The Welfare Cost of Business Cycles Revisited: Finite Lives and Cyclical Variation in Idiosyncratic Risk / Kjetil Storesletten, Chris I. Telmer, Amir Yaron.

Format:

Book

Author/Creator:

Storesletten, Kjetil.

Contributor:

National Bureau of Economic Research.

Telmer, Chris I.

Yaron, Amir.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8040.

NBER working paper series no. w8040

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

The Welfare Cost of Business Cycles Revisited

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2000.

Summary:

This paper investigates the welfare costs of business cycles in a heterogeneous agent, overlapping generations economy which is distinguished by idiosyncratic labor market risk. Aggregate variation arises both in terms of aggregate productivity shocks and countercyclical variation in the volatility of idiosyncratic shocks. Based on both aggregate data and microeconomic data from the Panel Study on Income Dynamics, we find the welfare benefits of eliminating aggregate variation to be large an order of magnitude larger than those originally documented by Lucas (1987). The key difference is countercyclical variation in idiosyncratic risk, which both amplifies the welfare cost of aggregate productivity shocks and imposes a cost of its own. The magnitude of these effects increases non-linearly in risk aversion. Our results support the increasingly popular notion that distributional effects are an important aspect of understanding the welfare cost of business cycles.

Notes:

Print version record

December 2000.