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Cost of Business Cycles under Incomplete Markets

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  • Yann Algan and Olivier Allais

Abstract

This paper reconsiders the costs of business cycles in context of incomplete market contracts. The main income variations being brought about by unemployment risks, imperfect insurance is likely to increases the costs of fluctuations in comparison to the Lucas's representative agent model. This investigation is run under a calibrated general equilibrium model where heterogeneous agents face both idiosyncratic employment shocks and aggregate productivity perturbations. Facing borrowing constraints, individuals are only insured through private savings and unemployment benefits. Aggregate shocks induce, contrary to previous studies, price variations which potentially amplify consumption fluctuations. The failure of complete market is thus found to sharply increase aggregate fluctuations costs, reaching nearly 4 percent of permanent consumption. This evaluation crucially depends on the nature of assurancial instruments against unemployment risks and on the extent of redistributive policies.

Suggested Citation

  • Yann Algan and Olivier Allais, 2001. "Cost of Business Cycles under Incomplete Markets," Computing in Economics and Finance 2001 144, Society for Computational Economics.
    • Handle: RePEc:sce:scecf1:144
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    More about this item

    Keywords

    Business cycles costs; Incomplete markets; Welfare;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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