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The Cost of Business Cycles Under Endogenous Growth

  • Gadi Barlevy

Robert E. Lucas, Jr. argued that the welfare gains from reducing aggregate consumption volatility are negligible. Subsequent work that revisited his calculation continued to find small welfare benefits, further reinforcing the perception that business cycles do not matter. This paper argues instead that fluctuations can affect welfare, by affecting the growth rate of consumption. I show that fluctuations can reduce growth starting from a given initial consumption, which can imply substantial welfare effects as Lucas himself observed. Empirical evidence suggests the welfare effects are likely to be substantial, about two orders of magnitude greater than Lucas' original estimates.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/0002828042002615
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 94 (2004)
Issue (Month): 4 (September)
Pages: 964-990

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Handle: RePEc:aea:aecrev:v:94:y:2004:i:4:p:964-990
Note: DOI: 10.1257/0002828042002615
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