Are Labor or Product Markets to Blame for Recessions?

Pete Klenow, Benjamin Malin and Mark Bils

No 715, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: Employment and hours appear far more cyclical than dictated by the behavior of productivity and consumption. This puzzle has been labeled "the labor wedge" - a cyclical wedge between the marginal product of labor and the marginal rate of substitution. The wedge can be broken into a product market wedge (price markup) and a labor market wedge (wage markup). Based on the wages of employees, the literature has attributed the wedge almost entirely to labor market distortions (see, e.g., Gali, Gertler, Lopez-Salido (2007) or Karabarbounis (2013)). Because employee wages may be smoothed versions of the true cyclical price of labor, however, we instead decompose the labor wedge using data on intermediate inputs, work-in-process inventories, and the self-employed. We find that price markup movements are just as important as wage markup movements -- including in the Great Recession and its aftermath. Thus, sticky prices and other forms of countercyclical price markups deserve a central place in business cycle research, alongside sticky wages and matching frictions.

Date: 2014
New Economics Papers: this item is included in nep-dge and nep-mac
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