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Disasters Everywhere: The Costs of Business Cycles Reconsidered

Author

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  • Jordá, Óscar
  • Schularick, Moritz
  • Taylor, Alan M.

Abstract

Business cycles are costlier and stabilization policies could be more beneficial than widely thought. This paper introduces a new test to show that all business cycles are asymmetric and resemble "mini-disasters." By this we mean that growth is pervasively fat-tailed and non-Gaussian. Using long-run historical data, we show empirically that this is true for advanced economies since 1870. Focusing on peacetime eras, we develop a tractable local projection framework to estimate consumption growth paths for normal and financial-crisis recessions. Introducing random coefficient local projections (RCLP) we get an easy and transparent mapping from the estimates to a calibrated simulation model with disasters of variable severity. Simulations show that substantial welfare costs arise not just from the large rare disasters, but also from the smaller but more frequent mini-disasters in every cycle. On average, and in post-WW2 data, even with low risk aversion, households would sacrifice about 15 percent of consumption to avoid such cyclical fluctuations.

Suggested Citation

  • Jordá, Óscar & Schularick, Moritz & Taylor, Alan M., 2020. "Disasters Everywhere: The Costs of Business Cycles Reconsidered," CEPR Discussion Papers 14559, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:14559
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    3. Abdoulaye Millogo, 2020. "Hysteresis Effects and Macroeconomics Gains from Unconventional Monetary Policies Stabilization," Cahiers de recherche 20-12, Departement d'Economique de l'École de gestion à l'Université de Sherbrooke.
    4. Kuvshinov, Dmitry & Richter, Björn & Zimmermann, Kaspar, 2022. "The shifts and the shocks: bank risk, leverage, and the macroeconomy," Working Paper Series 2672, European Central Bank.
    5. Rafael Cezar & Eric Monnet, 2021. "Capital Controls and Foreign Reserves against External Shocks: Combined or Alone?," Working papers 849, Banque de France.
    6. Basco, Sergi & Domènech, Jordi & Rosés, Joan R., 2021. "The redistributive effects of pandemics: Evidence on the Spanish flu," World Development, Elsevier, vol. 141(C).
    7. Iseringhausen, Martin & Petrella, Ivan & Theodoridis, Konstantinos, 2021. "Aggregate Skewness and the Business Cycle," Cardiff Economics Working Papers E2021/30, Cardiff University, Cardiff Business School, Economics Section.
    8. Yao Chen & Nuno Palma & Felix Ward, 2022. "Goldilocks: American precious metals and the Rise of the West," Tinbergen Institute Discussion Papers 22-063/VI, Tinbergen Institute.
    9. Fève, Patrick & Sanchez, Pablo Garcia & Moura, Alban & Pierrard, Olivier, 2021. "Costly default and skewed business cycles," European Economic Review, Elsevier, vol. 132(C).
    10. repec:ajk:ajkpbs:024 is not listed on IDEAS

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    More about this item

    Keywords

    Asymmetry; Fluctuations; local projections; macroprudential policy; Random coefficients;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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