Cyclicality of labor wedge and informal sector

- The 'labor wedge' is defined as the gap between the household's marginal rate of substitution and the firm's marginal product of labor.
- Empirical evidence suggests that the labor wedge is quite volatile and countercyclical.
- We argue that the presence of an 'informal sector' can provide a key for understanding the observed labor wedge dynamics.

Empirical evidence suggests that the labor wedge, defined as the gap between the firm's marginal product of labor and the household's marginal rate of substitution, is quite volatile and countercyclical. This article argues that the presence of an 'informal sector' can provide a key for understanding the observed countercyclical behavior of the labor wedge.