Markups, Gaps, and the Welfare Costs of Business Fluctuations

47 Pages Posted: 1 Jun 2006 Last revised: 26 Oct 2010

See all articles by Jordi Galí

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Mark Gertler

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

David Lopez-Salido

Board of Governors of the Federal Reserve System

Multiple version iconThere are 4 versions of this paper

Date Written: March 2002

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

Gali, Jordi and Gertler, Mark and Lopez-Salido, David, Markups, Gaps, and the Welfare Costs of Business Fluctuations (March 2002). NBER Working Paper No. w8850. Available at SSRN: https://ssrn.com/abstract=305076

Jordi Gali (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

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HOME PAGE: http://www.econ.upf.es/~gali

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Mark Gertler

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

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