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The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours

68 Pages Posted: 2 Sep 2010 Last revised: 20 Nov 2010

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER)

Ulf Soderstrom

Bocconi University

Antonella Trigari

Bocconi University - Department of Economics

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Date Written: September 1, 2010

Abstract

We use a standard quantitative business cycle model with nominal price and wage rigidities to estimate two measures of economic inefficiency in recent U.S. data: the output gap (the gap between the actual and efficient levels of output) and the labor wedge (the wedge between households' marginal rate of substitution and firms' marginal product of labor). We establish three results. (i ) The output gap and the labor wedge are closely related, suggesting that most inefficiencies in output are due to the inefficient allocation of labor. (ii ) The estimates are sensitive to the structural interpretation of shocks to the labor market, which is ambiguous in the model. (iii ) Movements in hours worked are essentially exogenous, directly driven by labor market shocks, whereas wage rigidities generate a markup of the real wage over the marginal rate of substitution that is acyclical. We conclude that the model fails in two important respects: it does not give clear guidance concerning the efficiency of business cycle fluctuations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics.

Keywords: Business cycles, Eciency, Labor markets, Monetary Policy

JEL Classification: E32, E24, E52

Suggested Citation

Sala, Luca and Soderstrom, Ulf and Trigari, Antonella, The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours (September 1, 2010). Paolo Baffi Centre Research Paper No. 2010-81. Available at SSRN: https://ssrn.com/abstract=1669949 or http://dx.doi.org/10.2139/ssrn.1669949

Luca Sala (Contact Author)

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

Via Roentgen 1
Milan, 20136
Italy
+39 02 5836 3326 (Phone)

Ulf Soderstrom

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

Antonella Trigari

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

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