Asymmetric Business Cycle Risk and Government Policy

Rocio Madera, Fatih Guvenen, David Domeij and Christopher Busch

No 1567, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies the business-cycle variation in higher-order income risk—risks that are captured by moments higher than the variance. A key focus is the extent to which such risks can be smoothed within households or with government policies. To provide a broad perspective on these questions, we study panel data on individuals and households from the United States, Germany, and Sweden, covering more than three decades of data for each country. We find that the underlying variation in higher-order risk is remarkably similar across these countries that differ in many details of their labor markets. In particular, in all three countries, the variance of earnings changes is almost entirely constant over the business cycle, whereas the skewness of these shocks becomes much more negative in recessions. Government provided insurance, in the form of unemployment insurance, welfare benefits, aid to low income households, and the like, plays a more important role reducing downside risk in all three countries; the effectiveness is weakest in the United States, and most pronounced in Germany. The welfare benefits of social insurance policies for stabilizing skewness risk over the business cycle range from 1% of annual consumption for the US to 4.5% for Sweden.

Date: 2016
New Economics Papers: this item is included in nep-ias
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