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

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  • Sala, Luca

    ()
    (Department of Economics and IGIER)

  • Söderström, Ulf

    ()
    (Research Department, Central Bank of Sweden)

  • Trigari, Antonella

    ()
    (Department of Economics and IGIER)

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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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 246.

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Length: 72 pages
Date of creation: 01 Sep 2010
Date of revision:
Handle: RePEc:hhs:rbnkwp:0246

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

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References

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  1. 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, Board of Governors of the Federal Reserve System (U.S.) 1023, Board of Governors of the Federal Reserve System (U.S.).
  2. Alejandro Justiniano & Giorgio E. Primiceri & Andrea Tambalotti, 2009. "Investment Shocks and Business Cycles," NBER Working Papers 15570, National Bureau of Economic Research, Inc.
  3. David Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2010. "Firm-specific capital, nominal rigidities and the business cycle," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 990, Board of Governors of the Federal Reserve System (U.S.).
  4. Rochelle M. Edge & Michael T. Kiley & Jean-Philippe Laforte, 2007. "Natural rate measures in an estimated DSGE model of the U.S. economy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2007-08, Board of Governors of the Federal Reserve System (U.S.).
  5. Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312 National Bureau of Economic Research, Inc.
  6. Susanto Basu & John G. Fernald, 2009. "What do we know (and not know) about potential output?," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jul, pages 187-214.
  7. Neiss, Katharine & Nelson, Edward, 2001. "The Real Interest rate Gap as an Inflation Indicator," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2848, C.E.P.R. Discussion Papers.
  8. Lawrence J. Christiano & Mathias Trabandt & Karl Walentin, 2010. "Involuntary unemployment and the business cycle," CQER Working Paper, Federal Reserve Bank of Atlanta 2010-03, Federal Reserve Bank of Atlanta.
  9. Sustek, Roman, 2009. "Monetary Business Cycle Accounting," MPRA Paper 17518, University Library of Munich, Germany.
  10. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2008. "Monetary Policy Under Uncertainty in an Estimated Model with Labour Market Frictions," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6826, C.E.P.R. Discussion Papers.
  11. Urban Jermann & Vincenzo Quadrini, 2009. "Macroeconomic Effects of Financial Shocks," NBER Working Papers 15338, National Bureau of Economic Research, Inc.
  12. James R. Spletzer & Katharine G. Abraham & Jay C. Stewart, 1999. "Why Do Different Wage Series Tell Different Stories?," American Economic Review, American Economic Association, American Economic Association, vol. 89(2), pages 34-39, May.
  13. Gregory de Walque & Frank Smets & Raf Wouters, 2006. "Price Shocks in General Equilibrium: Alternative Specifications," CESifo Economic Studies, CESifo, CESifo, vol. 52(1), pages 153-176, March.
  14. Boivin, J. & Giannoni, M., 2007. "DSGE Models in a Data-Rich Environment," Working papers, Banque de France 162, Banque de France.
  15. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices, Review of Economic Dynamics 09-191, Review of Economic Dynamics.
  16. Michael Kiley, 2010. "Output gaps," 2010 Meeting Papers, Society for Economic Dynamics 266, Society for Economic Dynamics.
  17. Giorgio Primiceri & Alejandro Justiniano, 2009. "Potential and natural output," 2009 Meeting Papers, Society for Economic Dynamics 25, Society for Economic Dynamics.
  18. 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, Blackwell Publishing, vol. 40(8), pages 1713-1764, December.
  19. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999, Society for Computational Economics 1151, Society for Computational Economics.
  20. Katharine Neiss & Edward Nelson, 2002. "Inflation dynamics, marginal cost, and the output gap: evidence from three countries," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  21. Günter Coenen & Frank Smets & Igor Vetlov, 2009. "Estimation of the Euro Area Output Gap Using the NAWM," Bank of Lithuania Working Paper Series, Bank of Lithuania 5, Bank of Lithuania.
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Cited by:
  1. Jordi Galí & Frank Smets & Rafael Wouters, 2011. "Unemployment in an Estimated New Keynesian Model," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 2011, Volume 26, pages 329-360 National Bureau of Economic Research, Inc.
  2. Nicolas Groshenny, 2010. "Monetary Policy, Inflation and Unemployment In Defense of the Federal Reserve," CAMA Working Papers 2010-37, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  3. Luca Sala, 2013. "DSGE models in the frequency domain," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 504, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.

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