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Macroeconomic Priorities and Crash States

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  • Kevin Salyer

    (Department of Economics, University of California Davis)

Abstract

This paper reproduces Lucas's analysis of the costs of business cycles in an economy with a low probability, crash state in consumption growth. For reasonable parameter values, it is shown that the presence of a crash state dramatically increases the costs ofconsumption volatility. Specifically, for relative risk aversion around 5, households in the US economy would, in aggregate, pay over $60 billion (approximately 3% of consumption in 2001) to eliminate consumption uncertainty. The conclusion is that stabilization policy is important not for its effects on second moments but inreducing kurtosis by lowering both the probability and severity of a crash state.

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File URL: http://wp.econ.ucdavis.edu/05-5.pdf
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Bibliographic Info

Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 55.

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Length: 12
Date of creation: 06 Jul 2005
Date of revision:
Handle: RePEc:cda:wpaper:05-5

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Web page: http://www.econ.ucdavis.edu
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Keywords: business cycles; crash states;

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References

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  1. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  2. Per Krusell & Anthony A. Smith, Jr., . "On the Welfare Effects of Eliminating Business Cycles," GSIA Working Papers 243, Carnegie Mellon University, Tepper School of Business.
  3. Robert J. Barro, 2005. "Rare Events and the Equity Premium," NBER Working Papers 11310, National Bureau of Economic Research, Inc.
  4. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, January.
  5. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  6. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
  7. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
  8. Mehra, Rajnish & Prescott, Edward C., 1988. "The equity risk premium: A solution?," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 133-136, July.
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Cited by:
  1. Robert J. Barro, 2009. "Rare Disasters, Asset Prices, and Welfare Costs," American Economic Review, American Economic Association, vol. 99(1), pages 243-64, March.
  2. Robert J. Barro, 2006. "On the Welfare Costs of Consumption Uncertainty," NBER Working Papers 12763, National Bureau of Economic Research, Inc.
  3. Tirelli Mario & Turner Sergio, 2010. "Quantifying the Cost of Risk in Consumption," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-33, July.
  4. Philip Jung & Keith Kuester, 2008. "The (un)importance of unemployment fluctuations for welfare," Working Papers 08-31, Federal Reserve Bank of Philadelphia.
  5. Jung, Philip & Kuester, Keith, 2011. "The (un)importance of unemployment fluctuations for the welfare cost of business cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 35(10), pages 1744-1768, October.

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