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

  • Jung, Philip
  • Kuester, Keith

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

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