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Revisiting the Welfare Effects of Eliminating Business Cycles

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Author Info

  • Per Krusell

    (Princeton University)

  • Toshihiko Mukoyama

    (University of Virginia)

  • Aysegul Sahin

    (Federal Reserve Bank of New York)

  • Anthony A. Smith, Jr.

    (Yale University)

Abstract

We investigate the welfare effects of eliminating business cycles in a model with substantial consumer heterogeneity. The heterogeneity arises from uninsurable and idiosyncratic uncertainty in preferences and employment status. We calibrate the model to match the distribution of wealth in U.S. data and features of transitions between employment and unemployment. In comparison with much of the literature, we find rather large effects. For our benchmark model, we find welfare effects that, on average across all consumers, are of a bit more than one order of magnitude larger than those computed by Lucas (1987). When we distinguish long- from short-term unemployment, long-term unemployment being distinguished by poor (and highly procylical) employment prospects and low unemployment compensation, the average gain from eliminating cycles is as much as 1% in consumption equivalents. In addition, in both models, there are large differences across groups: very poor consumers gain a lot when cycles are removed (the long-term unemployed as much as around 30%), as do very rich consumers, whereas the majority of consumers---the "middle class"---sees much smaller gains from removing cycles. Inequality also rises substantially upon removing cycles. (Copyright: Elsevier)

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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 12 (2009)
Issue (Month): 3 (July)
Pages: 393-402

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Handle: RePEc:red:issued:08-211

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Keywords: Cost of business cycles; Incomplete markets; Heterogeneity;

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References

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  1. Tom Krebs, 2007. "Job Displacement Risk and the Cost of Business Cycles," American Economic Review, American Economic Association, American Economic Association, vol. 97(3), pages 664-686, June.
  2. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, American Economic Association, vol. 93(1), pages 1-14, March.
  3. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity in the Macroeconomy," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-37, Carnegie Mellon University, Tepper School of Business.
  4. Andrew Atkeson & Christopher Phelan, 1994. "Reconsidering the Costs of Business Cycles with Incomplete Markets," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 1994, Volume 9, pages 187-218 National Bureau of Economic Research, Inc.
  5. Per Krusell & Anthony A. Smith, Jr., 1999. "On the Welfare Effects of Eliminating Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 245-272, January.
  6. Mukoyama, Toshihiko & Sahin, Aysegul, 2006. "Costs of business cycles for unskilled workers," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(8), pages 2179-2193, November.
  7. Wolff, Edward N, 1994. "Trends in Household Wealth in the United States, 1962-83 and 1983-89," Review of Income and Wealth, International Association for Research in Income and Wealth, International Association for Research in Income and Wealth, vol. 40(2), pages 143-74, June.
  8. Sam Schulhofer-Wohl, 2008. "Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 761-780, October.
  9. Tom Krebs, 2006. "Multi-Dimensional Risk and the Cost of Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 640-658, October.
  10. Tom Krebs, 2003. "Growth and Welfare Effects of Business Cycles in Economies with Idiosyncratic Human Capital Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 846-868, October.
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  1. Why all the fuss about business cycles?
    by Economic Logician in Economic Logic on 2009-09-01 14:25:00
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