Layoff Risk, the Welfare Cost of Business Cycles, and Monetary Policy

65 Pages Posted: 14 Sep 2015 Last revised: 12 Apr 2019

Date Written: April 4, 2019

Abstract

The strongest predictor of changes in the Fed Funds rate in the period 1982–2008 was the layoff rate. That fact is puzzling from the perspective of representative-agent models of the economy, which imply that the welfare gains of stabilizing employment fluctuations are small. This paper augments a standard New Keynesian model with a labor market featuring countercyclical layoffs that lead to large,uninsurable, and permanent idiosyncratic wage declines. In our benchmark calibration, welfare may be increased by 1 percent of lifetime consumption or more when the central bank’s policy rule responds to the layoff rate instead of purely targeting inflation.

Keywords: Layoff risk, monetary policy, heterogeneous agents, business cycles

JEL Classification: E12, E21, E24, E43, E52, E58

Suggested Citation

Berger, David and Dew-Becker, Ian and Schmidt, Lawrence and Takahashi, Yuta, Layoff Risk, the Welfare Cost of Business Cycles, and Monetary Policy (April 4, 2019). Available at SSRN: https://ssrn.com/abstract=2659941 or http://dx.doi.org/10.2139/ssrn.2659941

David Berger

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Ian Dew-Becker (Contact Author)

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

Lawrence Schmidt

MIT Sloan School of Management ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://sites.google.com/site/lawrencedwschmidt/home

Yuta Takahashi

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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