Asymmetric markup responses to monetary shocks over the business cycle

A rich literature has long studied the asymmetric effects of monetary policy over the business cycle, generally presenting mixed results. Most of the empirical work, however, focuses on the responses of output and prices. Our analysis centres on the dynamics of the markup, given the key role that it plays in the transmission of monetary policy, the fact that it constitutes a key leading indicator for predicting economic and financial crises, its direct relationship with income distribution, and the scarce studies on the subject. Recent empirical findings suggest that the markup decreases (increases) in response to a monetary policy tightening (easing) shock, a counterintuitive result if we consider the basic New Keynesian model, which delivers a countercyclical response of the markup conditional on a monetary shock. We show that the dynamics of the markup depend on whether the monetary policy shock takes place during a period of expansion or recession, with the markup responding as expected in the New Keynesian model in recessions, but failing to do so in expansions. Our results have important policy implications, providing evidence that the transmission mechanism of monetary policy through the markup would not be operative during booms.