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Markups, Gaps and the Welfare Costs of Business Fluctuations

  • Galí, Jordi
  • Gertler, Mark
  • Lopez-Salido, Jose David

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. Finally, we derive a measure of the welfare costs of business cycles that is directly related to our gap variable, and which takes into account explicitly the existence of a varying aggregate inefficiency. When applied to postwar US data, for plausible parametrizations, our measure suggests welfare losses of fluctuations that are of a higher order of magnitude than those derived by Lucas (1987). It also suggests that the major postwar recessions involved substantial efficiency costs.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3212.

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Date of creation: Feb 2002
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Handle: RePEc:cpr:ceprdp:3212
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