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Working Paper

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

How can we measure the welfare benefit of ongoing stabilization? 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 5.81 percent of lifetime consumption, in which 80 percent is smoothed by the status quo, yielding a residual 1.05 percent to be tackled by policy.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.


Suggested Citation

Barros, Fernando , Jr., Fábio Gomes, and André Victor D. Luduvice. 2021. “The Welfare Costs of Business Cycles Unveiled: Measuring the Extent of Stabilization Policies.” Federal Reserve Bank of Cleveland, Working Paper No. 21-14. https://doi.org/10.26509/frbc-wp-202114