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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.

Suggested Citation

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