NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Resurrecting the Role of the Product Market Wedge in Recessions

Mark Bils, Peter J. Klenow, Benjamin A. Malin

NBER Working Paper No. 20555
Issued in October 2014, Revised in September 2015
NBER Program(s):   EFG   ME

Employment and hours appear far more cyclical than dictated by the behavior of productivity and consumption. This puzzle has been called “the labor wedge” — a cyclical intratemporal wedge between the marginal product of labor and the marginal rate of substitution of consumption for leisure. The intratemporal 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 intratemporal wedge almost entirely to labor market distortions. Because employee wages may be smoothed versions of the true cyclical price of labor, we instead examine the self-employed and intermediate inputs, respectively. Looking at the past quarter century in the U.S., we find that price markup movements are at least as important as wage markup movements — including in the Great Recession and its aftermath. Thus sticky prices and other forms of countercyclical markups deserve a central place in business cycle research, alongside sticky wages and matching frictions.

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Document Object Identifier (DOI): 10.3386/w20555

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