 Asset liquidity and the welfare costs of business cyclesPedro Brinca, Joao Duarte, Ana Melissa Ferreira and Valter Nobrega Nova SBE Working Paper Series from Universidade Nova de Lisboa, Nova School of Business and Economics Abstract: In this paper, we revisit the question of what the welfare costs of business cycles are with new insights. The seminal paper by Lucas (1987) found welfare costs to be negligible at around 1%, but subsequent literature focused on finding mechanisms that could rationalize larger welfare costs. Our study builds on recent research that incorporates incomplete markets, adjustment costs, and marginal propensities to consume to show that welfare costs can be substantial. Our calculations indicate that eliminating business cycle fluctuations would result in a 1.25% increase in welfare, as measured in consumption equivalents. Furthermore, using a 2-asset HANK model, we find a welfare cost of 2.6%. This result arises from considering portfolio adjustment costs, which generate a distribution of marginal propensities to consume along the income dimension that is empirically plausible and produces a share of (rich and poor) hand-to-mouth households that is consistent with recent findings. In periods of recession, these values rise to 11.1%. These results are particularly driven by effects from the price rigidity. Keywords: Welfare costs; Business cycles; Liquidity; Hand-to-mouth (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:unl:unlfep:wp667 Access Statistics for this paper More papers in Nova SBE Working Paper Series from Universidade Nova de Lisboa, Nova School of Business and Economics Contact information at EDIRC. |
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