Rockets, feathers and prices at the pump
By Paul Krugman
One of the sad paradoxes of politics is that few economic indicators matter more for public opinion — for voters’ evaluation of the government in power — than energy prices, especially the price of gasoline. This isn’t just a U.S. phenomenon: Inflation driven by soaring energy prices has undermined the popularity of leaders across the Western world.
Why do I call this a sad paradox? Because while policy can have a big effect on overall inflation, it doesn’t have much effect on energy prices. The rates for oil, in particular, are set on world markets; even the U.S. president (let alone the leaders of smaller nations) has very little influence on that global price.
Still, given the political salience of prices at the pump, leaders have an incentive to do what they can to bring them down a bit or at least be seen making the effort. So a few days ago, President Joe Biden tweeted an appeal to “the companies running gas stations” to “bring down the price at the pump to reflect the cost you’re paying for the product.” Indeed, wholesale gasoline prices have fallen about 80 cents a gallon since early June, while the decline in retail prices has been less sharp.
The reaction to his remark was, however, savage. Most notably, Jeff Bezos in a tweet assailed Biden for “a deep misunderstanding of market dynamics.”
Hmmm. Did Bezos check out what we know about the market dynamics of gasoline prices (or order an underling to do it)? Because if he had, he would have learned that there are some peculiar things about those dynamics — things that suggest at least some justification for Biden’s appeal. Serious research offers a lot more support for the idea that market power has played a role in recent inflation than you’d imagine from the ridicule heaped on that notion, including from Democratic-leaning economists.
Monopoly power isn’t the principal cause of inflation, which has been driven by an overheated economy plus external shocks like Russia’s invasion of Ukraine. But there’s a reasonable case that monopoly power is a cause of inflation — and blanket attacks on the mere possibility reflect, well, a deep misunderstanding of market dynamics.
So, about those gas prices. As economists at the St. Louis Fed recently pointed out, there’s a long-standing phenomenon in the fuel market known as asymmetric pass-through or, more colorfully, rockets and feathers. When oil prices shoot up, prices at the pump shoot up right along with them (the rocket). And when oil prices plunge, prices at the pump eventually fall, but much more gradually (the feather).
Why this asymmetry? There have been a number of economic papers trying to understand it, pretty much all of which stress the market power of companies that face limited competition (something Bezos surely knows a lot about). The clearest explanation I’ve seen is in a relatively old paper by Severin Borenstein, Richard Gilbert and A. Colin Campbell. I’d summarize their argument as follows: When oil prices shoot up, owners of gas stations feel empowered not just to pass on the cost but also to raise their markups, because consumers can’t easily tell whether they’re being gouged when prices are going up everywhere. And gas stations may hang on to these extra markups for a while even when oil prices fall.
Is there evidence for this story? Yes. Notably, the rockets and feathers phenomenon seems to be strongest in areas where individual gas stations face relatively little competition.
In such a situation, badgering gas stations to get their prices down may actually make some sense. We can argue about its effectiveness, but it’s not stupid, given what we know about the relevant market dynamics.
What at least a few readers may notice is that the market power explanation of rockets and feathers — an explanation with an impeccable academic pedigree, developed by economists who had no obvious political ax to grind — is pretty much the same argument politicians like Sen. Elizabeth Warren, D-Mass., have made about how monopoly power may have contributed to recent overall inflation. That is, some politicians argue that corporations have taken advantage of a generally inflationary environment to jack up their markups, in the belief that they will face less public backlash than they would in normal times. And this exploitation of market power has pushed inflation even higher.
Such arguments have been greeted with ridicule and horror, even from some Democratic-leaning pundits and economists. But they make sense, as illustrated by the economic literature on gasoline prices. And what appears to be true for gasoline prices could be true more generally. New research by Mike Konczal and Niko Lusiani of the Roosevelt Institute, a progressive think tank, finds that recent price increases have been largest in industries that had limited competition — as indicated by high markups — even before the pandemic. That’s the same kind of evidence that supports the view that asymmetric adjustment of gasoline prices reflects market power.
The mystery to me is why so many of my colleagues, in both the economics profession and the economics punditocracy, have had such an extremely negative reaction to any suggestion that market power might be playing a role in inflation and that presidential jawboning might make some contribution to anti-inflation strategy.
Are they afraid that Biden is about to turn into Turkey’s president, Recep Tayyip Erdogan, who has rejected conventional macroeconomics and sent inflation soaring, officially to 79% and probably much higher in reality? Look, that’s not going to happen. Biden isn’t even going to do a Richard Nixon and try to use price controls to suppress inflation while urging the Fed to keep interest rates low. Unlike Donald Trump, who yelled at the Fed a lot, the current administration has been scrupulously hands-off as the Fed tightens policy to bring inflation down — a policy, by the way, that I support, even though there’s a real risk of recession.
The only thing I can conclude is that even supposedly center-left members of the economics commentariat are viscerally appalled by anything that even hints at populism. And this, I’m afraid, says more about the profession than it does about the economy.