TY  - JOUR
AU  - Storesletten,Kjetil
AU  - Telmer,Chris I.
AU  - Yaron,Amir
TI  - The Welfare Cost of Business Cycles Revisited: Finite Lives and Cyclical Variation in Idiosyncratic Risk
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 8040
PY  - 2000
Y2  - December 2000
UR  - http://www.nber.org/papers/w8040
L1  - http://www.nber.org/papers/w8040.pdf
N1  - Author contact info:
Kjetil Storesletten
Federal Reserve Bank of Minneapolis
Research Department
90 Hennepin Ave.
Minneapolis, MN 55401
Tel: +47 22844009
E-Mail: kjetil.storesletten@econ.uio.no

Amir Yaron
The Wharton School
University of Pennsylvania
2256 Steinberg-Dietrich Hall
Philadelphia, PA 19104-6367
Tel: 215/898-1241
Fax: 215/898-6200
E-Mail: yaron@wharton.upenn.edu
AB  - This paper investigates the welfare costs of business cycles in a heterogeneous agent, overlapping generations economy which is distinguished by idiosyncratic labor market risk.  Aggregate variation arises both in terms of aggregate productivity shocks and countercyclical variation in the volatility of idiosyncratic shocks.  Based on both aggregate data and microeconomic data from the Panel Study on Income Dynamics, we find the welfare benefits of eliminating aggregate variation to be large   an order of magnitude larger than those originally documented by Lucas (1987).  The key difference is countercyclical variation in idiosyncratic risk, which both amplifies the welfare cost of aggregate productivity shocks and imposes a cost of its own.  The magnitude of these effects increases non-linearly in risk aversion.  Our results support the increasingly popular notion that distributional effects are an important aspect of understanding the welfare cost of business cycles.
ER  -