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Markups, gaps, and the welfare costs of business fluctuations

  • Jordi Galí

    ()

    (Centre de Recerca en Economia Internacional)

  • Mark Gertler

    ()

    (New York University)

  • J. David López-Salido

    ()

    (Banco de España)

In this paper we present a simple, theory-based measure of the variations in aggregate economic efficiency associated with business fluctuations. We decompose this indicator, which we refer to as “the gap”, into two constituent parts: a price markup and a wage markup, and show that the latter accounts for the bulk of the fluctuations in our gap measure. We also demonstrate the connection between our gap measure and the gap between ouput and its natural level, a more traditional indicator of aggregate inefficiency. Finally, we derive a measure of the welfare costs of business cycles that is directly related to our gap variable. Our welfare measure corresponds to the inefficient component of economic fluctuations, and should thus be interpreted as a lower bound to the costs of the latter. When applied to postwar U.S. data, for some plausible parametrizations, our measure indicates non-negligible welfare losses of gap fluctuations. The results, however, hinge critically on some key parameters, including the intertemporal elasticity of labor supply.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/02/Fic/dt0204e.pdf
File Function: First version, January 2002
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0204.

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Length: 39 pages
Date of creation: Jan 2002
Date of revision:
Handle: RePEc:bde:wpaper:0204
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