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The (un)importance of unemployment fluctuations for the welfare cost of business cycles

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Listed author(s):
  • Jung, Philip
  • Kuester, Keith

Abstract

This paper studies the cost of business cycles within a real business cycle model with search and matching frictions in the labor market. We endogenously link both the cyclical fluctuations and the mean level of unemployment to the aggregate business cycle risk. The key result of the paper is that business cycles are costly: fluctuations over the cycle induce a higher average unemployment rate since employment is nonlinear in the job-finding rate and the past unemployment rate. We show this analytically for a special case of the model. We then calibrate the model to U.S. data. For the calibrated model, too, business cycles cause higher average unemployment; the welfare cost of business cycles can easily be an order of magnitude larger than Lucas's (1987) estimate. The cost of business cycles is the higher the lower the value of nonemployment is, or, equivalently, the lower is the disutility of work. The ensuing cost of business cycles rises further when workers' skills depreciate during unemployment.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 10 (October)
Pages: 1744-1768

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:10:p:1744-1768
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

Keywords: Cost of business cycles Unemployment Search and matching;

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Cited by:

  1. Jung, Philip & Kuhn, Moritz, 2012. "Earnings losses and labor mobility over the life-cycle," MPRA Paper 40287, University Library of Munich, Germany.
  2. Alisdair McKay & Tamas Papp, 2011. "Accounting for Idiosyncratic Wage Risk Over the Business Cycle," Boston University - Department of Economics - Working Papers Series WP2011-028, Boston University - Department of Economics.
  3. Tuinstra, Jan & Wegener, Michael & Westerhoff, Frank, 2014. "Positive welfare effects of trade barriers in a dynamic partial equilibrium model," Journal of Economic Dynamics and Control, Elsevier, vol. 48(C), pages 246-264.
  4. Vincent Boitier & Antoine Lepetit, 2014. "Reduced form wage equations in the credible bargaining model," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01088831, HAL.
  5. Acedański, Jan, 2016. "Youth unemployment and welfare gains from eliminating business cycles — The case of Poland," Economic Modelling, Elsevier, vol. 57(C), pages 248-262.
  6. Eleni Iliopulos & François Langot & Thepthida Sopraseuth, 2014. "Welfare Cost of Fluctuations: when Labor Market Search Interacts with Financial Frictions," Documents de travail du Centre d'Economie de la Sorbonne 14042, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  7. Jana Kremer & Nikolai Stähler, 2016. "Structural and Cyclical Effects of Tax Progression," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 72(1), pages 41-73, March.
  8. Alisdair McKay, "undated". "Idiosyncratic risk, insurance, and aggregate consumption dynamics: a likelihood perspective," Boston University - Department of Economics - Working Papers Series 2013-013, Boston University - Department of Economics.
  9. Michael Reiter, 2013. "On The Welfare Costs Of Unemployment Fluctuations," 2013 Meeting Papers 962, Society for Economic Dynamics.
  10. Tuinstra, Jan & Wegener, Michael & Westerhoff, Frank, 2013. "Positive welfare effects of trade barriers in a dynamic equilibrium model," BERG Working Paper Series 91, Bamberg University, Bamberg Economic Research Group.
  11. Moyen, Stéphane & Stähler, Nikolai, 2009. "Unemployment insurance and the business cycle: prolong benefit entitlements in bad times?," Discussion Paper Series 1: Economic Studies 2009,30, Deutsche Bundesbank, Research Centre.

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