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Title: Markups, Gaps and the Welfare Costs of Business Fluctuations

Author(s): Jordi Galí, Mark Gertler and Jose David Lopez-Salido

Publication Date: February 2002

Keyword(s): business cycles, countercyclical markups and welfare costs

Programme Area(s): International Macroeconomics

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 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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Bibliographic Reference

Galí, J, Gertler, M and Lopez-Salido, J. 2002. 'Markups, Gaps and the Welfare Costs of Business Fluctuations'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3212