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Federal Reserve Bank of Minneapolis
Staff Report
Resurrecting the Role of the Product Market Wedge in Recessions
Mark Bils
Peter J. Klenow
Benjamin A. Malin

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 United States, we find that price markup movements are at least as important as wage markup movements — including during 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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Mark Bils & Peter J. Klenow & Benjamin A. Malin, Resurrecting the Role of the Product Market Wedge in Recessions, Federal Reserve Bank of Minneapolis, Staff Report 516, 09 Oct 2015.
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Keywords: Business cycles; Labor wedge; Price markups; Wage markups
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