Despite the significant shifts in macro-economic relationships and in policymakers’ preferences arising from a rise in market power, the net effect on the (level and variability) of the optimal interest rate path is more modest. At root, that is because of the trade-off inducing nature of mark-up shocks. Third, the presence of market power and higher mark-ups also has implications for the level of output in the economy which could provide additional incentives to generate inflation. Monopolistic competition implies that output is inefficiently low relative to its (perfectly competitive) social optimum. For sufficiently small deviations from the steady state, the policymakers’ loss function can be re-written to reflect that inefficiency:  16  All speeches are available online at www.bankofengland.co.uk/speeches  16  𝐿𝑡 = 𝜋𝑡2 + 𝜆𝑥𝑡2 − Ʌ𝑥𝑡  (14)  where  Ʌ=  1 (1 − 𝜃)(1 − 𝛽𝜃) 1−𝛼 2 𝜖 𝜃 1 − 𝛼 + (𝜍 + 𝜑)𝜖  (15)  The optimal targeting rule is also then altered to become:  𝜋𝑡 =  1 𝜑 + 𝛼 −1 1 −1 (𝜎 + ) − 𝑥𝑡 𝜖2 1−𝛼 𝜖  (16)  The additional constant term reflects the well-known inflationary bias under discretionary policy, first articulated by Barro and Gordon (1983). Output at a sub-optimally low level increases the incentives of a discretionary policymaker to run looser monetary policy to push output towards its social optimum, thereby generating an inflation bias.
Overall, then, while the theoretical and empirical evidence suggests it is possible higher market power and mark-ups may have come at some cost in lower investment and innovation, the evidence is not overwhelming and certainly would not imply that the aggregate effect is large. A second relationship explored recently is between market power and the labour share. 15  Autor et al (2017)  find a negative empirical relationship using measures of market concentration among US companies. And Díez et al (2018) and De Loecker and Eeckhout (2018) identify a weakly negative relationship between 15  The relationship between labour, capital and profit shares is discussed in Barkai (2017). 8  All speeches are available online at www.bankofengland.co.uk/speeches  8  mark-ups and the labour share. If we run regressions similar to those in Díez et al for UK-listed companies (Table 3), we also find a negative relationship between mark-ups and the labour share. 16  The analysis presented here, and much of the recent literature, is based around estimates that suggest a secular rise in firm-level mark-ups. Some caution is advisable when drawing conclusions from these results. First, some macro-economic evidence points to falling, rather than rising, company mark-ups/margins (for example, Chen, Imbs and Scott (2009, 2004)). Second, some mismeasurement may be at play in the estimation of mark-ups (for example, Traina (2018)). These uncertainties in the measurement of mark-ups should be borne in mind in interpreting what follows.