Discussion paper

DP3212 Markups, Gaps and the Welfare Costs of Business Fluctuations

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.


Gertler, M, J Gali and J Lopez-Salido (eds) (2002), “DP3212 Markups, Gaps and the Welfare Costs of Business Fluctuations”, CEPR Press Discussion Paper No. 3212. https://cepr.org/publications/dp3212