The labor wedge: MRS vs. MPN |
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| Affiliation: | 1. Northwestern, United States;2. NBER, United States;3. Chicago Booth, United States;1. Bank of England, Threadneedle Street, London EC2R 8AH, United Kingdom;2. University of Surrey, Guildford, GU27XH, United Kingdom;3. University of Cambridge, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom;1. University of Cambridge, United Kingdom;2. University of Lausanne, Switzerland;3. CEPR, United States;4. London Business School, United Kingdom;1. University of Minnesota and FRB of Minneapolis, United States;2. University of Minnesota, FRB of Minneapolis, NBER, and CEPR, United States |
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| Abstract: | Do fluctuations of the labor wedge, defined as the gap between the firm's marginal product of labor (MPN) and the household's marginal rate of substitution (MRS), reflect fluctuations of the gap between the MPN and the real wage or fluctuations of the gap between the real wage and the MRS? For many countries and most forcefully for the United States, fluctuations of the labor wedge predominantly reflect fluctuations of the gap between the real wage and the MRS. As a result, business cycle theories of the labor wedge should primarily focus on improving the household side of the labor market. Explanations of the labor wedge based on departures of the representative firm's MPN from the real wage are rejected by the data because the labor share of income is not strongly procyclical. |
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| Keywords: | Labor wedge Marginal rate of substitution Marginal product of labor Labor share |
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