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Markups, Gaps, and the Welfare Costs of Business Fluctuations

  • Jordi Gali
  • Mark Gertler
  • J. David Lopez-Salido

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 U.S. 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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8850.

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Date of creation: Mar 2002
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Publication status: published as Jordi Galí & Mark Gertler & J. David López-Salido, 2007. "Markups, Gaps, and the Welfare Costs of Business Fluctuations," The Review of Economics and Statistics, MIT Press, vol. 89(1), pages 44-59, November.
Handle: RePEc:nbr:nberwo:8850
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