Revisiting the Cost of Business Cycles: A Demand Shock Channel

This paper estimates the welfare cost of the US business cycle episodes over the period 1964-2018. Under the restriction of a balanced growth path, the representative consumer in a frictionless, competitive business cycle world would reduce GDP by around 1.3 percent each year to eliminate business cycle risk; our estimates are comparable to the benefits of stabilization by Barro(2009). The key to these results is augmentation with investment-specific shocks `a la Fisher (2006) to a standard business cycle model.