On the Welfare Costs of Consumption Uncertainty

Robert J. Barro

No 12763, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Satisfactory calculations of the welfare cost of aggregate consumption uncertainty require a framework that replicates major features of asset prices and returns, such as the high equity premium and low risk-free rate. A Lucas-tree model with rare but large disasters is such a framework. In a baseline simulation, the welfare cost of disaster risk is large -- society would be willing to lower real GDP by about 20% each year to eliminate all disaster risk, including wars. In contrast, the welfare cost from usual economic fluctuations is much smaller, though still important -- corresponding to lowering GDP by around 1.5% each year.

JEL-codes: E21 E44 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cba, nep-dge, nep-mac and nep-upt
Date: 2006-12
Note: EFG ME PE
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