The Welfare Costs of Business Cycles Unveiled: Measuring the Extent of Stabilization Policies

RePEc Short ID: pdo535
ORCID iD: 0000-0003-4096-5897

Barros, Fernando; Gomes, Fabio; Luduvice, Andre

doi:10.26509/frbc-wp-202114r2

Working Paper Revision

The Welfare Costs of Business Cycles Unveiled: Measuring the Extent of Stabilization Policies

Abstract: How can we measure the welfare benefit of ongoing stabilization policies? We develop a methodology to calculate the welfare cost of business cycles taking into account that observed consumption is partially smoothed. We propose a decomposition that disentangles consumption in a mix of laissez-faire (absent policies) and riskless components. With a novel identification strategy, we estimate the span of stabilization power. In our preferred specification, we find that the welfare cost of total fluctuations is 11 percent of lifetime consumption, of which 82 percent is smoothed by the status quo policies, yielding a residual 1.8 percent of consumption to be tackled by policymakers.

Keywords: business cycles; consumption; stabilization; macroeconomic history;

JEL Classification: E21; E32; E63; N10;

https://doi.org/10.26509/frbc-wp-202114r2