Disasters Everywhere: The Costs of Business Cycles Reconsidered

Òscar Jordà, Moritz Schularick () and Alan Taylor
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Òscar Jordà: Federal Reserve Bank of San Francisco, UC Davis - University of California [Davis] - UC - University of California
Moritz Schularick: ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, Kiel Institute for the World Economy - Kiel Institute for the World Economy
Alan Taylor: UC Davis - University of California [Davis] - UC - University of California, CEPR - Center for Economic Policy Research, NBER - The National Bureau of Economic Research

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Abstract: Rare disaster models assume that growth is afflicted by a negative-mean and left-skewed component, which, if eliminated, could produce first-order welfare gains, unlike other models of business cycle costs. This paper introduces a new test to show that many if not most business cycles are asymmetric in this way, and resemble "mini-disasters" in addition to the widely studied rare disaster events with which we are familiar, typically wars. Using long-run historical data, we show empirically that this holds for advanced economies since 1870 in peacetime. We develop a tractable local projection framework to estimate consumption processes in normal and financial crisis recessions. Introducing random coefficient local projections, we get an easy and transparent mapping from estimates to a calibrated simulation model of disasters with variable severity. Our simulations show that substantial welfare costs arise from the smaller but more frequent mini-disasters. On average, even with low risk aversion, households would be willing to pay between 5 and 12% of deterministic consumption to avoid these events based on their average historical frequency and severity.

Date: 2024-03
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Published in IMF Economic Review, 2024, International Monetary Fund Economic Review, 72 (1), pp.116-151. ⟨10.1057/s41308-023-00221-y⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:spmain:hal-05448566

DOI: 10.1057/s41308-023-00221-y

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