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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)

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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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00492204.

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Date of creation: Mar 2010
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Handle: RePEc:hal:cesptp:halshs-00492204

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Keywords: Business cycle costs; inefficiency gap; new-Keynesian macroeconomics.;

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  1. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  2. Alan Sutherland, 2002. "A Simple Second-Order Solution Method for Dynamic General Equilibrium Models," Discussion Paper Series, Department of Economics 0211, Department of Economics, University of St. Andrews.
  3. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
  4. Orazio P. Attanasio & James Banks & Costas Meghir & Guglielmo Weber, 1995. "Humps and Bumps in Lifetime Consumption," NBER Working Papers 5350, National Bureau of Economic Research, Inc.
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