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Markups, Gaps, and the Welfare Costs of Business Fluctuations

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

Abstract

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.

Suggested Citation

  • Jordi Gali & Mark Gertler & J. David Lopez-Salido, 2002. "Markups, Gaps, and the Welfare Costs of Business Fluctuations," NBER Working Papers 8850, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8850
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    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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