I review research on the behavior of the labor wedge, the ratio
between the marginal rate of substitution of consumption for leisure
and the marginal product of labor. According to competitive,
market-clearing macroeconomic models, the ratio is easy to measure
and should be equal to the sum of consumption and labor taxes.
The observation that the wedge is higher in continental Europe than
in the United States has proved useful for understanding the extent
to which taxes can explain differences in labor market outcomes.
The observation that the ratio rises during recessions suggests some
failure of competitive, market-clearing macroeconomic models at
business cycle frequencies. The latter observation has guided recent
research, including work on sticky wage models and job search models.
(JEL E24, E32, J64)
"Convergence in Macroeconomics: The Labor Wedge." American Economic Journal: Macroeconomics,
Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital
Business Fluctuations; Cycles
Unemployment: Models, Duration, Incidence, and Job Search