Tuesday, March 07, 2006

Monetary Policy and Monopoly Power

While I was writing the Monopoly Power post, I thought about an interesting monetary effect. If capital markets ultimately regulate monopoly power, then, all else being equal, the extent of monopoly power that a firm can exhibit will be directly related to interest rates. When interest rates are high, like in the late nineteenth century, firm’s monopoly power will also be relatively high. When interest rates are relatively low like today, monopoly power will be low.

So, in addition to the other effects that accompany the Federal Reserve raising interest rates to cool the economy, we can add increasing firms’ monopoly power. (Other than commodity companies, each firm has a monopoly on its brand and products.) So rising interest rates give firms extra margin to raise prices, which increases the dead weight loss to the economy and contributes to the slowing effect.

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