We thank two anonymous referees for their particularly helpful remarks and suggestions. We are also indebted to Paul Beaudry, Jean-Pascal Bénassy, Florin Bilbiie, and Franck Portier for helpful comments. Any errors and omissions are ours.
Markups and the Welfare Cost of Business Cycles: A Reappraisal
Article first published online: 26 JUL 2012
© 2012 The Ohio State University
Journal of Money, Credit and Banking
Volume 44, Issue 5, pages 995–1014, August 2012
How to Cite
HAIRAULT, J.-O. and LANGOT, F. (2012), Markups and the Welfare Cost of Business Cycles: A Reappraisal. Journal of Money, Credit and Banking, 44: 995–1014. doi: 10.1111/j.1538-4616.2012.00519.x
- Issue published online: 26 JUL 2012
- Article first published online: 26 JUL 2012
- Received April 2, 2010; and accepted in revised form September 7, 2011.
- business cycle costs;
- inefficiency gap;
- New Keynesian macroeconomics
Gali, Gertler, and Lopez-Salido (2007) recently show quantitatively that fluctuations in the efficiency of resource allocation do not generate sizable welfare costs. In their economy, which is distorted by monopolistic competition in the steady state, we show that they underestimate the welfare cost of these fluctuations by ignoring the negative effect of aggregate volatility on average consumption and leisure. As monopolistic suppliers, both firms and workers aim to preserve their expected markups; the interaction between aggregate fluctuations and price-setting behavior results in average consumption and employment levels that are lower than their counterparts in the flexible-price economy. This level effect increases the efficiency cost of business cycles. It is all the more sizable with the degree of inefficiency in the steady state, lower labor–supply elasticities, and when prices instead of wages are rigid.