Discussion Paper Details

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Title: Inefficient employment decisions, entry costs, and the cost of fluctuations

Author(s): Wouter Den Haan and Petr Sedlacek

Publication Date: September 2009

Keyword(s): business cycles and frictions

Programme Area(s): International Macroeconomics

Abstract: Fluctuations in firms' revenues reduce firms' viability and are costly from a social welfare point of view even when agents are risk neutral if (i) the decision to continue operating a firm is not efficient at the margin so that fluctuations shorten firms' life expectancy (because they increase the chance revenue levels are such that discontinuation is unavoidable) and (ii) the shortening of the life expectancy reduces entry. Welfare consequences are large, even for moderate fluctuations: Implied estimates for the per period costs of business cycles can easily be equal to several percentage points of GDP. These estimates are based on a direct measurement of cyclical changes in the value added generated by workers that recently were not employed. This extensive margin measure of the cyclical change in output is of independent interest.

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Bibliographic Reference

Den Haan, W and Sedlacek, P. 2009. 'Inefficient employment decisions, entry costs, and the cost of fluctuations'. London, Centre for Economic Policy Research.