The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours

Luca Sala (luca.sala@unibocconi.it), Ulf Söderström (ulf.soderstrom@riksbank.se) and Antonella Trigari (antonella.trigari@unibocconi.it)

No 365, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: We use a standard quantitative business cycle model with nominal price and wage rigidities to estimate two measures of economic inefficiency in recent U.S. data: the output gap - the gap between the actual and effcient levels of output - and the labor wedge|the wedge between households' marginal rate of substitution and firms' marginal product of labor. We establish three results. (i ) The output gap and the labor wedge are closely related, suggesting that most inefficiencies in output are due to the inesocient allocation of labor. (ii ) The estimates are sensitive to the structural interpretation of shocks to the labor market, which is ambiguous in the model. (iii ) Movements in hours worked are essentially exogenous, directly driven by labor market shocks, whereas wage rigidities generate a markup of the real wage over the marginal rate of substitution that is acyclical. We conclude that the model fails in two important respects: it does not give clear guidance concerning the e Sociency of business cycle fluctations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics.

Date: 2010
New Economics Papers: this item is included in nep-bec, nep-cba, nep-dge, nep-lab and nep-mac
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Citations: View citations in EconPapers (24)

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Working Paper: The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours (2010)
Working Paper: The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours (2010)
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