Capital-market imperfections and countercyclical markups: Theory and evidence

During recessions, output prices seem to rise relative to wages and raw-material prices. One explanation is that imperfectly competitive firms compete less aggressively during recessions. That is, markups of price otter marginal cost are countercyclical. We present a model of countercyclical markups based on capital-market imperfections. During recessions, liquidity-constrained firms boost short-run profits by raising prices to cut their investments in market share. We provide evidence from the supermarket industry in support of this theory. During regional and macroeconomic recessions, more financially constrained supermarket chains raise their prices relative to less financially constrained chains.