Market Polarization and the Phillips Curve

The Phillips curve has flattened out over the last decades. Inspired by the recent evidence about the dynamics of the industrial structure in some advanced economies, we build up a model that rationalizes this phenomenon as a result of the observed increase in polarization in many industries, where a small number of large companies coexist with many smaller ones. The model features endogenous market entry, exit and up/downgrading of firms in the technology ladder, and firms set their price taking into account its effect on the market price. Large firms find strategically optimal to dampen the response of their price changes, thus cushioning the shocks to their marginal costs by changing their markups countercyclically. In this way, increased polarization emerges in the model as a key explanatory factor behind the muted responses of inflation to movements in the output gap