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Markups and the Welfare Cost of Business Cycles: A Reappraisal

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  • Jean-Olivier Hairault

    (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, IZA - Institute for the Study of Labor)

  • François Langot

    (IZA - Institute for the Study of Labor, GAINS-TEPP - Université du Maine, CEPREMAP - Centre pour la recherche économique et ses applications - Centre pour la recherche économique et ses applications)

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    Abstract

    Gali et al. (2007) have recently shown quantitatively that fluctuations in the efficiency of resource allocation do not generate sizable welfare costs. In their economy, which is distorted by monopolistic competition in the steady state, we show that they underestimate the welfare cost of these fluctuations by ignoring the negative effect of aggregate volatility on average consumption and leisure. As monopolistic suppliers, both firms and workers aim to preserve their expected markups; the interaction between aggregate fluctuations and price-setting behavior results in average consumption and employment levels that are lower than their counterparts in the flexible-price economy. This level effect increases the efficiency cost of business cycles. It is all the more sizable with the degree of inefficiency in the steady state, lower labor-supply elasticities, and when prices instead of wages are rigid.

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    Bibliographic Info

    Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number hal-00623281.

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    Date of creation: 2012
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    Publication status: Published, Journal of Money, Credit and Banking, 2012, 44, 5, 995-1014
    Handle: RePEc:hal:cesptp:hal-00623281

    Note: View the original document on HAL open archive server: http://hal.archives-ouvertes.fr/hal-00623281
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    Web page: http://hal.archives-ouvertes.fr/

    Related research

    Keywords: Business cycle costs; inefficiency gap; New-Keynesian Macroeconomics;

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    1. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 825-860, October.
    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. Sutherland, Alan, 2002. "A Simple Second-Order Solution Method For Dynamic General Equilibrium Models," CEPR Discussion Papers 3554, C.E.P.R. Discussion Papers.
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