On the Welfare Costs of Consumption Uncertainty

Robert Barro

Scholarly Articles from Harvard University Department of Economics

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.

Date: 2006
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Published in NBER Working Paper Series

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Working Paper: On the Welfare Costs of Consumption Uncertainty (2006)
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