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Markups and the Welfare Cost of Business Cycles: A Reappraisal

  • JEAN‐OLIVIER HAIRAULT
  • FRANÇOIS LANGOT

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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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2012.00519.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): 5 (08)
Pages: 995-1014

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i:5:p:995-1014
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. 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.
  2. Orazio Attanasio & James Banks & Costas Meghir & Guglielmo Weber, 1995. "Humps and bumps in lifetime consumption," IFS Working Papers W95/14, Institute for Fiscal Studies.
  3. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  4. 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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