Welfare cost of monetary and fiscal policy shocks
Views & Download
This paper provides estimates of the welfare cost of volatility attributable to monetary and fiscal policy shocks. It uses a continuous-time stochastic dynamic general equilibrium model based on a recursive utility function that disentangles risk aversion from intertemporal substitution. We find that monetary and fiscal policy shocks may lead to opposite welfare effects: negative for monetary growth shocks, but positive for government expenditure shocks. Furthermore, we find that welfare costs are sensitive to the parameter values chosen for risk aversion and intertemporal substitution, and we conclude that welfare costs are potentially much larger than that found by Lucas, forcing some modification of the policy conclusions associated with Lucas's pioneering work.
Welfare cost of volatility , Recursive utility , Stochastic general equilibrium models
Evans, L. & Kenc, T. (2003). Welfare cost of monetary and fiscal policy shocks. Macroeconomic Dynamics, 7 (2), pp. 212-238.
Cambridge University Press