Market Power and Inflation

This paper examines the extent to which a decline in market power could have contributed to the general decline in inflation rates experienced in developed countries during the 1990s. *Staff economist of the Division of International Finance of the Federal Reserve Board. Email: [email protected]. I wish to thank Jon Faust, Steve Kamin, and Jeremy Rudd for valuable comments. This paper represents views of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or other members of its staff. The 1990s witnessed a widespread general decline in in°ation in most developed economies. While low in°ation in the early part of the decade is commonly thought to re°ect low rates of economic growth, in°ation continued to remain low in many countries as economic conditions strengthened. And, as documented in Andersen and Wascher (2001), in°ation remained below the rates forecast by standard econometric models and by survey participants. There are several possible explanations for these facts, including structural changes in the natural rate of unemployment and monetary authorities taking advantage of economic growth to focus on keeping in°ation low. This paper examines another explanation receiving popular attention and highlighted in recent work by Rogo® (2003), the claim that ̄rm's market power has been eroded by increased domestic and international competition. Several factors could plausibly have led to increased competition during the 1990s, including: