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


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. Our results show 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 codes: E32, E21, E63, N10


Suggested citation: Barros Jr, Fernando, Fabio Augusto R. Gomes, and André Victor D. Luduvice. 2022. "The Welfare Costs of Business Cycles Unveiled: Measuring the Extent of Stabilization Policies." Working Paper No. 21-14R. Federal Reserve Bank of Cleveland. https://doi.org/10.26509/frbc-wp-202114r.

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