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Markups and the Welfare Cost of Business Cycles: A Reappraisal

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  • JEAN‐OLIVIER HAIRAULT
  • FRANÇOIS LANGOT

Abstract

Gali et al. (2007) have recently shown in a quantitative way that inefficient fluctuations in the allocation of resources do not generate sizable welfare costs. In this note, we show that their evaluation underestimates the welfare costs of inefficient fluctuations and propose a biased estimate of the impact of structural distortions on business cycle costs. As monopolistic suppliers, both firms and households aim at preserving their expected markups ; the interaction between aggregate fluctuations in the efficiency gap and price-setting behaviors results in making average consumption and employment lower than their counterparts in the flexible price economy. This level increases the welfare cost of business cycles. It is all the more sizable in that the degree of inefficiency is structurally high at the steady state.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2012.00519.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): 5 (08)
Pages: 995-1014

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i:5:p:995-1014

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 825-860.
  2. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  3. Alan Sutherland, 2002. "A Simple Second-Order Solution Method for Dynamic General Equilibrium Models," Discussion Paper Series, Department of Economics 200211, Department of Economics, University of St. Andrews.
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