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The euro area inefficiency gap

  • Jordi Galí

    ()

    (Centre de Recerca en Economia Internacional)

  • Mark Gertler

    ()

    (New York University)

  • J. David López-Salido

    ()

    (Banco de España)

We construct a measure of Euro area cyclical efficiency, following the approach developed in Galí, Gertler and López-Salido (2002). Our measure –which we call "the gap"– corresponds to the inverse of price over social marginal cost. Here we present a time series of this gap for the Euro area, as well as its two components, the price and wage markups. As with U.S. data, the ineficiency gap is highly procyclical, and driven largely by countercyclical movements in the wage markup. We are also able to use our gap variable to derive a theory-based measure of the output gap for the Euro area, which we can compare to other measures often used in applications. We also show that the wage markup moves closely with the unemployment rate, as theory would suggest. Finally, we discuss briefly the implications for monetary policy of alternative interpretations of our evidence.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/03/Fic/dt0302e.pdf
File Function: First version, April 2003
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0302.

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Length: 37 pages
Date of creation: Apr 2003
Date of revision:
Handle: RePEc:bde:wpaper:0302
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  1. Hall, Robert E, 1997. "Macroeconomic Fluctuations and the Allocation of Time," Journal of Labor Economics, University of Chicago Press, vol. 15(1), pages S223-50, January.
  2. Danthine, J.P. & Donaldson, J.B., 1993. "Non-Walrassian Economies," Papers 93-02, Columbia - Graduate School of Business.
  3. Jordi Gali, 1996. "Technology, Employment, and the Business Cycle: Do Technology Shocks Explain Aggregate Fluctuations," NBER Working Papers 5721, National Bureau of Economic Research, Inc.
  4. Jordi Galí & Mark Gertler & J. David López-Salido, 2002. "Markups, gaps, and the welfare costs of business fluctuations," Banco de Espa�a Working Papers 0204, Banco de Espa�a.
  5. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
  6. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  7. Jean-Pierre DANTHINE & John B. DONALDSON, 1988. "Efficiency Wages and the Real Business Cycle," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 8803, Université de Lausanne, Faculté des HEC, DEEP.
  8. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  9. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1986. "A Time Series Analysis of Representative Agent Models of Consumption andLeisure Choice Under Uncertainty," NBER Working Papers 1981, National Bureau of Economic Research, Inc.
  10. Gali, Jordi, 1996. "Unemployment in dynamic general equilibrium economies," European Economic Review, Elsevier, vol. 40(3-5), pages 839-845, April.
  11. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
  12. Julio J. Rotemberg & Michael Woodford, 1999. "The Cyclical Behavior of Prices and Costs," NBER Working Papers 6909, National Bureau of Economic Research, Inc.
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