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The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours

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  • Sala, Luca
  • Söderström, Ulf
  • Trigari, Antonella

Abstract

We use a standard quantitative business cycle model with nominal price and wage rigidities to estimate two measures of economic inefficiency in recent U.S. data: the output gap---the gap between the actual and efficient levels of output---and the labor wedge---the wedge between households' marginal rate of substitution and firms' marginal product of labor. We establish three results. (i) The output gap and the labor wedge are closely related, suggesting that most inefficiencies in output are due to the inefficient allocation of labor. (ii) The estimates are sensitive to the structural interpretation of shocks to the labor market, which is ambiguous in the model. (iii) Movements in hours worked are essentially exogenous, directly driven by labor market shocks, whereas wage rigidities generate a markup of the real wage over the marginal rate of substitution that is acyclical. We conclude that the model fails in two important respects: it does not give clear guidance concerning the efficiency of business cycle fluctuations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8005.

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Date of creation: Sep 2010
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Handle: RePEc:cpr:ceprdp:8005

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Keywords: Business cycles; Efficiency; Labor markets; Monetary policy;

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References

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  1. Neiss, Katharine & Nelson, Edward, 2001. "The Real Interest rate Gap as an Inflation Indicator," CEPR Discussion Papers 2848, C.E.P.R. Discussion Papers.
  2. Malin Adolfson & Stefan Laséen & Jesper Lindé & Lars E.O. Svensson, 2011. "Optimal monetary policy in an operational medium-sized DSGE model," International Finance Discussion Papers 1023, Board of Governors of the Federal Reserve System (U.S.).
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  4. Susanto Basu & John G. Fernald, 2009. "What do we know (and not know) about potential output?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 187-214.
  5. Mark Gertler & Luca Sala & Antonella Trigari, 2008. "An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1713-1764, December.
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  9. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2008. "Monetary Policy Under Uncertainty in an Estimated Model with Labour Market Frictions," CEPR Discussion Papers 6826, C.E.P.R. Discussion Papers.
  10. Urban Jermann & Vincenzo Quadrini, 2009. "Macroeconomic Effects of Financial Shocks," NBER Working Papers 15338, National Bureau of Economic Research, Inc.
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  13. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary policy under uncertainty in micro-founded macroeconometric models," Working Paper Series 2005-15, Federal Reserve Bank of San Francisco.
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  15. Katharine Neiss & Edward Nelson, 2002. "Inflation dynamics, marginal cost, and the output gap: evidence from three countries," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  16. Edge, Rochelle M. & Kiley, Michael T. & Laforte, Jean-Philippe, 2008. "Natural rate measures in an estimated DSGE model of the U.S. economy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2512-2535, August.
  17. Sustek, Roman, 2009. "Monetary Business Cycle Accounting," MPRA Paper 17518, University Library of Munich, Germany.
  18. Günter Coenen & Frank Smets & Igor Vetlov, 2009. "Estimation of the Euro Area Output Gap Using the NAWM," Bank of Lithuania Working Paper Series 5, Bank of Lithuania.
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Citations

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Cited by:
  1. Jordi Galí & Frank Smets & Rafael Wouters, 2011. "Unemployment in an Estimated New Keynesian Model," Working Papers 541, Barcelona Graduate School of Economics.
  2. Groshenny, Nicolas, 2013. "Monetary Policy, Inflation And Unemployment: In Defense Of The Federal Reserve," Macroeconomic Dynamics, Cambridge University Press, vol. 17(06), pages 1311-1329, September.
  3. Luca Sala, 2013. "DSGE models in the frequency domain," Working Papers 504, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.

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