academic papers

Capacity Utilization, Markup Cyclicality, and Inflation Dynamics

Capacity Utilization, Markup Cyclicality, and Inflation Dynamics

By Ignacio González and Vasudeva Ramaswamy

This academic paper studies the relationship between firms’ decisions about capacity, its utilization, and inflation. To do this, we introduce endogenous capacity utilization into a New Keynesian (NK) model. In our model, firms set capacity under demand uncertainty, utilizing both an effort margin and capacity expansion to meet demand. This mechanism implies that firm-level productivity and desired markups depend on the capacity utilization rate, enabling us to derive three (state-dependent) results that have proven challenging for NK models. First, following an expansionary demand shock, the aggregate markup responds procyclically when desired markups rise enough to overcome the effect of nominal rigidities. Secondly, the labor share can respond countercyclically for reasons that are empirically consistent, namely, when labor productivity, propelled by the utilization of idle capacity, increases more than wages. Finally, inflation typically displays a hump-shaped response, but can also respond sharply during periods of high capacity utilization due to fast-rising markups and reduced productivity effects. We detail the conditions under which these results arise. Using Bayesian IRF matching, we illustrate that our model provides a highly plausible fit to the data. Our results underscore the importance of capacity for the macroeconomic debate surrounding the determinants, dynamics and distributional effects of inflation.

academic papers

Corporate Taxation and Market Power Wealth

Corporate Taxation and Market Power Wealth
By Lídia Brun, Ignacio González, Juan Antonio Montecino

This academic paper studies the aggregate and distributional effects of corporate tax reforms when market power is heterogeneous across sectors and firms. We use a life-cycle model with incomplete markets in which capital and equity do not always move in tandem when corporate tax policy changes. On the one hand, the increase in the tax rate causes the classic partial equilibrium effect of reducing the demand for capital; an effect that can be greater or lower depending on different provisions in the tax code and sectoral characteristics. On the other hand, the tax reduces the value of equity wealth due to the taxation of market power rents, shifting the supply of aggregate equity downward and inducing a negative effect on equity returns. This novel general equilibrium effect reduces the cost of capital and is typically expansionary. In our benchmark calibration, designed to match a realistic distribution of markups and markdowns, as well as the institutional details of the US corporate tax code, increasing the corporate tax rate can stimulate aggregate investment, output, and wages. Moreover, this reform reduces wealth inequality as equity shareholders are concentrated at the top.