Sectoral inflation persistence, market concentration, and imperfect common knowledge

Abstract

Previous studies have stressed that inflation dynamics exhibit substantial dispersion across sectors. Using US producer price data, we present evidence that sectoral inflation persistence is negatively correlated with market concentration, which is difficult to reconcile with the prediction of the standard model of monopolistic competition. To better explain the data, we incorporate imperfect common knowledge into the monopolistic competition model introduced by Melitz and Ottaviano (2008). In the model, pricing complementarity among firms increases as market concentration decreases. Because higher pricing complementarity generates greater inflation persistence, our model successfully replicates the observed negative correlation between inflation persistence and market concentration across sectors.