Markups and the Welfare Cost of Business Cycles: A Reappraisal
AbstractGali 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 InfoPaper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number hal-00623281.
Date of creation: 2012
Date of revision:
Publication status: Published, Journal of Money, Credit and Banking, 2012, 44, 5, 995-1014
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Business cycle costs; inefficiency gap; New-Keynesian Macroeconomics;
Other versions of this item:
- Jean-Olivier Hairault & François Langot, 2010. "Markups and the Welfare Cost of Business Cycles : A Reappraisal," UniversitÃ© Paris1 PanthÃ©on-Sorbonne (Post-Print and Working Papers) halshs-00492204, HAL.
- NEP-ALL-2011-09-22 (All new papers)
- NEP-CBA-2011-09-22 (Central Banking)
- NEP-DGE-2011-09-22 (Dynamic General Equilibrium)
- NEP-MAC-2011-09-22 (Macroeconomics)
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