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Disasters Everywhere: The Costs of Business Cycles Reconsidered

Òscar Jordà (), Moritz Schularick () and Alan M. Taylor ()
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Òscar Jordà: Federal Reserve Bank of San Francisco
Moritz Schularick: Kiel Institute for the World Economy
Alan M. Taylor: University of California, Davis

IMF Economic Review, 2024, vol. 72, issue 1, No 4, 116-151

Abstract: 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.

JEL-codes: E13 E21 E22 E32 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1057/s41308-023-00221-y

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