Measuring the Cost of Economic Fluctuations with Preferences that Rationalize the Equity Premium
AbstractLucas (2003) argues that the potential welfare gains from stabilizing the business cycle are small. In fact, he shows that the benefits of eliminating all economic fluctuations are small, both in an absolute sense and when compared to the potential gains from other reforms. His estimates are obtained using standard preferences. In this paper, I show that a model consistent with observed data on asset returns leads to very different conclusions. Calibrating preferences to observed asset market data raises the estimated welfare gains from completely eliminating aggregate fluctuations by approximately two orders of magnitude. Most of the gains, however, come from the elimination of low frequency contributions.
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Bibliographic InfoPaper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-256.
Length: 24 pages
Date of creation: 08 Oct 2006
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welfare cost; fluctuations; stabilization;
Other versions of this item:
- Angelo Melino, 2010. "Measuring the cost of economic fluctuations with preferences that rationalize the equity premium," Canadian Journal of Economics, Canadian Economics Association, vol. 43(2), pages 405-422, May.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-10-21 (All new papers)
- NEP-DGE-2006-10-21 (Dynamic General Equilibrium)
- NEP-MAC-2006-10-21 (Macroeconomics)
- NEP-UPT-2006-10-21 (Utility Models & Prospect Theory)
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