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Labor-Market Wedge under Engel Curve Utility: Cyclical Substitution between Necessities and Luxuries

Yongsung Chang (), Andreas Hornstein and Marios Karabarbounis
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Andreas Hornstein: Federal Reserve Bank of Richmond
Marios Karabarbounis: Federal Reserve Bank of Richmond

No 2018rwp-128, Working papers from Yonsei University, Yonsei Economics Research Institute

Abstract: In booms, households substitute luxuries for necessities, e.g., food away from home for food at home. Ignoring this cyclical pattern of composition changes in the consumption basket makes the labor-market wedge- a measure of inefficiency that reflects the gap between the marginal rate of substitution and the real wage- appear to be more volatile than it actually is. Based on the household expenditure pattern across 10 consumption categories in the Consumer Expenditure Survey, we show that taking into account these composition changes can explain 6-15% of the cyclicality in the measured labor-market wedge.

Date: 2018-08
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