Price and Wage Stickiness, Inflation, and Profits

This paper investigates the relationship between firm markups and inflation.  In contrast to work that has emphasized price dispersion and search costs, we focus on flexibility or stickiness of prices and wages.  We argue that in sectors of the economy with industries characterized by flexible prices and sticky wages, markups should respond positively to inflation.  Industry markups in sectors with both flexible prices and flexible wages theoretically may rise or fall in response to an increase in the price level.  Markups of industries in sectors of the economy in which prices are sticky should respond negatively to inflation, with an absolutely larger negative response occurring in sticky-price industries with flexible wages.  Empirical analysis of U.S. industries provides support for nearly all of these theoretical predictions.