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Stabilization versus Insurance

Author

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  • James Costain and Michael Reiter

Abstract

Fluctuations of representative agent economies are not very costly. So if business cycles matter, it must be because agents face uninsured idiosyncratic risk which is somehow worsened by aggregate fluctuation. Idiosyncratic risk could be counteracted either through aggregate stabilization or public insurance provision. Our framework allows us to ask which of these mechanisms is optimal. We study a real business cycle model with a job matching function which, under non-distortionary full insurance, would decentralize the optimum. However, we assume public insurance can only be financed by distorting labor taxes, and that there is moral hazard in job search behavior. Without insurance, workers save to smooth their consumption. Our dynamic general equilibrium simulation characterizes the asset distribution in terms of a few moments. We interpolate the value function and check accuracy by new methods. We find that aggregate fluctuations have little average effect on unemployment, but they are costly because recessions greatly increase the probability of remaining unemployed long enough to deplete asset buffer stocks. Both public insurance provision and aggregate stabilization by increasing the procyclicality of tax collection imply nontrivial benefits.

Suggested Citation

  • James Costain and Michael Reiter, 2001. "Stabilization versus Insurance," Computing in Economics and Finance 2001 161, Society for Computational Economics.
  • Handle: RePEc:sce:scecf1:161
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    References listed on IDEAS

    as
    1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 183-209, June.
    2. Robert Shimer, 2004. "The Consequences of Rigid Wages in Search Models," Journal of the European Economic Association, MIT Press, vol. 2(2-3), pages 469-479, 04/05.
    3. Storesletten, Kjetil & Telmer, Chris I. & Yaron, Amir, 2001. "The welfare cost of business cycles revisited: Finite lives and cyclical variation in idiosyncratic risk," European Economic Review, Elsevier, vol. 45(7), pages 1311-1339.
    4. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
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    Citations

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    Cited by:

    1. Philip Jung & Keith Kuester, 2008. "The (un)importance of unemployment fluctuations for welfare," Working Papers 08-31, Federal Reserve Bank of Philadelphia, revised 29 Apr 2009.
    2. Andersen, Torben M & Svarer, Michael, 2009. "Business Cycle Dependent Unemployment Insurance," CEPR Discussion Papers 7334, C.E.P.R. Discussion Papers.
    3. Leena Rudanko, 2011. "Aggregate and Idiosyncratic Risk in a Frictional Labor Market," American Economic Review, American Economic Association, vol. 101(6), pages 2823-2843, October.
    4. 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.
    5. Miguel Casares & Antonio Moreno & Jesús Vázquez, 2012. "Wage stickiness and unemployment fluctuations: an alternative approach," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 3(3), pages 395-422, September.
    6. Nils Gornemann & Keith Kuester & Makoto Nakajima, 2012. "Monetary policy with heterogeneous agents," Working Papers 12-21, Federal Reserve Bank of Philadelphia.
    7. Per Krusell & Toshihiko Mukoyama & Ayşegül Şahin, 2010. "Labour-Market Matching with Precautionary Savings and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 77(4), pages 1477-1507.
    8. repec:bof:bofrdp:urn:nbn:fi:bof-201510061415 is not listed on IDEAS
    9. Mauro F Roca, 2009. "Search in the Labor Market under Imperfectly Insurable Income Risk," IMF Working Papers 09/188, International Monetary Fund.
    10. Singh, Aarti, 2010. "Human capital risk in life-cycle economies," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 729-738, September.
    11. Moyen, Stéphane & Stähler, Nikolai, 2014. "Unemployment Insurance And The Business Cycle: Should Benefit Entitlement Duration React To The Cycle?," Macroeconomic Dynamics, Cambridge University Press, vol. 18(03), pages 497-525, April.
    12. Eerola, Essi & Määttänen, Niku, 2015. "Matching and credit frictions in the housing market," Research Discussion Papers 20/2015, Bank of Finland.
    13. repec:eee:ecmode:v:67:y:2017:i:c:p:125-135 is not listed on IDEAS
    14. 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.
    15. Mark Strøm Kristoffersen, 2012. "Business Cycle Dependent Unemployment Benefits with Wealth Heterogeneity and Precautionary Savings," Economics Working Papers 2012-19, Department of Economics and Business Economics, Aarhus University.
    16. Eerola, Essi & Määttänen, Niku, 2013. "Matching in the housing market with risk aversion and savings," ETLA Working Papers 3, The Research Institute of the Finnish Economy.
    17. Carl Walsh, 2007. "Inflation Targeting and the Role of Real Objectives," Research and Policy Notes 2007/02, Czech National Bank, Research Department.

    More about this item

    Keywords

    business cycles; heterogeneous agents; matching;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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