Countercyclical Earnings Risk and the Welfare Costs of Business Cycles

John Braxton (), Marlena Eley (), Jonathan Rothbaum () and Shannon Sledz ()
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John Braxton: University of Wisconsin-Madison
Marlena Eley: University of Wisconsin
Jonathan Rothbaum: US Census Bureau
Shannon Sledz: Joint Committee on Taxation

No 18962, IZA Discussion Papers from IZA Network @ LISER

Abstract: Using linked employee--employer data, we show that recessions shift earnings changes toward negative skewness through more frequent layoffs, larger post-layoff earnings losses, and fewer upward job moves. We discipline a Bewley--Huggett--Aiyagari model with directed search and aggregate productivity shocks using these empirical moments. The calibrated model reproduces the cyclical shift in earnings skewness and implies that eliminating business cycles generates a welfare gain equivalent to 4.9% of consumption on average. This gain falls to essentially zero when cyclical changes in individual labor market risk are removed. Persistent earnings losses following recessionary job loss account for most of the welfare cost.

Keywords: countercyclical earnings risk; business cycles; earnings skewness; search friction; welfare costs (search for similar items in EconPapers)
JEL-codes: D52 E21 E32 J31 J64 (search for similar items in EconPapers)
Date: 2026-09
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