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A quantitative defense of stabilization policy

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  • Darrel Cohen
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    Abstract

    In an analysis of the value of growth and stabilization of consumption, Robert Lucas presents a stunning set of calculations implying that a permanent increase in the growth rate of consumption of only one-tenth percentage point per year is worth nearly 50 times as much to consumers as complete elimination of consumption variability. This is because the higher growth of consumption is worth a lot while the reduced variability is worth virtually nothing (at least in the post-war United States). Taken at face value, such a result supports the pursuit of feasible growth policies but calls into serious question the study and practice of macroeconomic stabilization policy even if complete elimination of variance were feasible and costless. Primarily by considering alternative meanings of stabilization, this paper establishes that the value of stabilization relative to the value of higher growth is about 100 times larger than the corresponding figure in Lucas. The new quantitative estimates suggest, assuming feasibility, that even a small permanent increase in the growth rate of consumption is worth a lot, but so too is stabilization in the alternative senses considered here.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2000-34.

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    Date of creation: 2000
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    Handle: RePEc:fip:fedgfe:2000-34

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    Related research

    Keywords: Economic stabilization ; Business cycles ; Consumption (Economics);

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    References

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    1. Christina D. Romer, 1999. "Changes in Business Cycles: Evidence and Explanations," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 23-44, Spring.
    2. Imrohoruglu, Ayse, 1989. "Cost of Business Cycles with Indivisibilities and Liquidity Constraints," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1364-83, December.
    3. Susanto Basu & Alan M. Taylor, 1999. "Business Cycles in International Historical Perspective," NBER Working Papers 7090, National Bureau of Economic Research, Inc.
    4. J. Bradford De Long & Lawrence H. Summers, . "How Does Macroeconomic Policy Matter?," J. Bradford De Long's Working Papers _130, University of California at Berkeley, Economics Department.
    5. Andrew Atkeson & Christopher Phelan, 1994. "Reconsidering the Costs of Business Cycles with Incomplete Markets," NBER Working Papers 4719, National Bureau of Economic Research, Inc.
    6. Otrok, Christopher, 2001. "On measuring the welfare cost of business cycles," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 61-92, February.
    7. Caballero, Ricardo J., 1999. "Aggregate investment," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 12, pages 813-862 Elsevier.
    8. Friedman, Milton, 1993. "The "Plucking Model" of Business Fluctuations Revisited," Economic Inquiry, Western Economic Association International, vol. 31(2), pages 171-77, April.
    9. Blinder, Alan S, 1987. "Keynes, Lucas, and Scientific Progress," American Economic Review, American Economic Association, vol. 77(2), pages 130-36, May.
    10. J. Bradford DeLong & Lawrence H. Summers, 1988. "How Does Macroeconomic Policy Affect Output?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(2), pages 433-494.
    11. Kim, C-J & Nelson, C-R, 1997. "Friedman's Plucking Model of Business Fluctuations : Tests and Estimates of Permanent and Transitory Components," Working Papers 97-06, University of Washington, Department of Economics.
    12. Daniel E. Sichel, 1992. "Inventories and the three phases of the business cycle," Working Paper Series / Economic Activity Section 128, Board of Governors of the Federal Reserve System (U.S.).
    13. repec:fth:harver:1418 is not listed on IDEAS
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    Cited by:
    1. Gadi Barlevy, 2005. "The cost of business cycles and the benefits of stabilization," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 32-49.
    2. Satyajit Chatterjee & Dean Corbae, 2003. "On the welfare gains of eliminating a small likelihood of economic crises: A case for stabilization policies?," Working Papers 03-20, Federal Reserve Bank of Philadelphia.
    3. Satyajit Chatterjee & Dean Corbae, 2000. "On the welfare gains of reducing the likelihood of economic crises," Working Paper 0015, Federal Reserve Bank of Cleveland.
    4. Gadi Barlevy, 2004. "The Cost of Business Cycles and the Benefits of Stabilization: A Survey," NBER Working Papers 10926, National Bureau of Economic Research, Inc.

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