Evaluating the Costs of Business Cycles in Models of Endogenous Growth
In his famous monograph, Lucas (1987) put forth an argument that the welfare gains from reducing the volatility of aggregate consumption are negligible. Subsequent work that has revisited Lucas' calculation has continued to find only small benefits from reducing the volatility of consumption, further reinforcing the perception that business cycles don't matter. This paper argues instead that fluctuations could affect the growth process, which could have much larger effects than consumption volatility. I present an argument for why stabilization could increase growth without a reduction in current consumption, which could imply substantial welfare effects as Lucas (1987) already observed in his calculation. Empirical evidence and calibration exercises suggest that the welfare effects can be quite substantial, possibly as much as two orders of magnitude greater than Lucas' original estimates.
|Date of creation:||Mar 2000|
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