Reconsidering the Costs of Business Cycles with Incomplete Markets
In this paper, we measure the potential welfare gains from counter-cyclical policy in an economy with incomplete markets. In the course of conducting this measurement, we focus on two questions as central to the determination of those potential gains: (1) what is the likely effect of counter-cyclical policy on the nature of the income risk faced by individuals in the economy, and (2) what are the likely general equilibrium effects brought about as asset prices change due to the implementation of counter-cyclical policies? In taking up the first question, we see it as critical to distinguish whether the main effect of counter-cyclical policy is to directly reduce the income risk faced by each individual or is simply to reduce the correlation across individuals in the income risk that they face. We present a model of the wage and employment risk faced by individuals over the cycle in which the levels of those risks are chosen endogenously. On the basis of that model, we argue that the main effect of counter- cyclical policy aimed at reducing aggregate fluctuations may be simply to remove the correlation across individuals in the unemployment risk that they face. We then use asset price data to argue that in an incomplete markets framework, the potential welfare gains from counter-cyclical policy are close to zero.
|Date of creation:||Apr 1994|
|Date of revision:|
|Publication status:||published as Reconsidering the Costs of Business Cycles with Incomplete Markets , Andrew Atkeson, Christopher Phelan. in NBER Macroeconomics Annual 1994, Volume 9 , Fischer and Rotemberg. 1994|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Angus Deaton & Christina Paxson, 1993.
"Intertemporal Choice and Inequality,"
NBER Working Papers
4328, National Bureau of Economic Research, Inc.
- J. Bradford De Long & Lawrence H. Summers, . "How Does Macroeconomic Policy Matter?," J. Bradford De Long's Working Papers _130, University of California at Berkeley, Economics Department.
- Heaton, John & Lucas, Deborah J, 1996.
"Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing,"
Journal of Political Economy,
University of Chicago Press, vol. 104(3), pages 443-87, June.
- John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
- Orazio Attanasio & Steven J. Davis, 1994.
"Relative Wage Movements and the Distribution of Consumption,"
NBER Working Papers
4771, National Bureau of Economic Research, Inc.
- Attanasio, Orazio & Davis, Steven J, 1996. "Relative Wage Movements and the Distribution of Consumption," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1227-62, December.
- Brainard, William & Dolbear, F T, 1971. "Social Risk and Financial Markets," American Economic Review, American Economic Association, vol. 61(2), pages 360-70, May.
- John H. Cochrane & Lars Peter Hansen, 1992.
"Asset Pricing Explorations for Macroeconomics,"
NBER Working Papers
4088, National Bureau of Economic Research, Inc.
- Constantinides,George & Duffie,Darrel, 1992.
"Asset pricing with heterogeneous consumers,"
Discussion Paper Serie A
381, University of Bonn, Germany.
- repec:fth:harver:1418 is not listed on IDEAS
- J. Bradford DeLong & Lawrence H. Summers, 1988. "How Does Macroeconomic Policy Affect Output?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(2), pages 433-494.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:4719. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.