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Magnitude X on the Richter Scale: Welfare Cost of Business Cycles in Developing Countries

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  • Stephane Pallage and Michel A. Robe

Abstract

Economic fluctuations are much stronger in developing countries than in the United States. Yet, while a large literature debates what constitutes a reasonable estimate of the welfare cost of business cycles in the US, it remains an open question how large that cost is in developing countries. Using several model economies, we provide such a measure for a large number of low--income countries. Our first main result is that the welfare cost of output fluctuations per se is far from trivial in those countries, and typically averages 15 to 30 times the corresponding estimate for the US. Our second major result is that, in many poor countries, that cost may in fact exceed the welfare cost of significantly lower growth.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2001 with number 97.

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Date of creation: 01 Apr 2001
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Handle: RePEc:sce:scecf1:97
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Keywords: Business cycles; consumption volatility; growth; welfare costs;

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Find related papers by JEL classification:
  • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
  • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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  1. Reinhart, Carmen & Ostry, Jonathan, 1991. "Private Saving and Terms of Trade Shocks," MPRA Paper 13716, University Library of Munich, Germany.
  2. Imrohoruglu, Ayse, 1989. "Cost of Business Cycles with Indivisibilities and Liquidity Constraints," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1364-83, December.
  3. Michel A. Robe & Stephane Pallage, 2000. "Foreign Aid And The Business Cycle," Computing in Economics and Finance 2000 107, Society for Computational Economics.
  4. Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-37, February.
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  6. Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 29-42.
  7. Jim Dolmas, 1998. "Risk Preferences and the Welfare Cost of Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(3), pages 646-676, July.
  8. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  9. Andrew Atkeson & Christopher Phelan, 1994. "Reconsidering the Costs of Business Cycles with Incomplete Markets," NBER Chapters, in: NBER Macroeconomics Annual 1994, Volume 9, pages 187-218 National Bureau of Economic Research, Inc.
  10. C. John McDermott & Eswar S Prasad & Pierre-Richard Agénor, 1999. "Macroeconomic Fluctuations in Developing Countries; Some Stylized Facts," IMF Working Papers 99/35, International Monetary Fund.
  11. Mendoza, Enrique G., 1997. "Terms-of-trade uncertainty and economic growth," Journal of Development Economics, Elsevier, vol. 54(2), pages 323-356, December.
  12. Per Krusell & Anthony A. Smith, Jr., 1999. "On the Welfare Effects of Eliminating Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 245-272, January.
  13. Ramey, Garey & Ramey, Valerie A, 1995. "Cross-Country Evidence on the Link between Volatility and Growth," American Economic Review, American Economic Association, vol. 85(5), pages 1138-51, December.
  14. Jonathan David Ostry & Carmen Reinhart, 1991. "Private Saving and Terms of Trade Shocks; Evidence From Developing Countries," IMF Working Papers 91/100, International Monetary Fund.
  15. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  16. Pritchett, Lant, 2000. "Understanding Patterns of Economic Growth: Searching for Hills among Plateaus, Mountains, and Plains," World Bank Economic Review, World Bank Group, vol. 14(2), pages 221-50, May.
  17. Gadi Barlevy, 2000. "Evaluating the Costs of Business Cycles in Models of Endogenous Growth," Discussion Papers 1287, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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Cited by:

  1. Moore, Winston, 2010. "Managing the Process of Removing Capital Controls: What Does the Literature Suggest?," MPRA Paper 21584, University Library of Munich, Germany.
  2. Boucekkine, Raouf & Martinez, Blanca, 2003. "Replacement, adoption and economic dynamics: lessons from a canonical creative destruction model," Structural Change and Economic Dynamics, Elsevier, vol. 14(3), pages 339-359, September.

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