Welfare Costs of Idiosyncratic and Aggregate Consumption Shocks

Abstract

I estimate welfare benefits of eliminating idiosyncratic consumption shocks unrelated to the business cycle as 47.3% of household utility and benefits of eliminating idiosyncratic shocks related to the business cycle as 3.4% of utility. Estimates of the former substantially exceed earlier ones because I distinguish between idiosyncratic shocks related/unrelated to the business cycle, estimate the negative skewness of shocks, target moments of idiosyncratic shocks from household-level CEX data, and target market moments. Benefits of eliminating aggregate shocks are 7.7% of utility. Policy should focus on insuring idiosyncratic shocks unrelated to the business cycle, such as the death of a household’s prime wage earner and job layoffs not necessarily related to recessions.

Keywords: welfare costs of consumption shocks; idiosyncratic consumption shocks; welfare costs of idiosyncratic consumption shocks; incomplete consumption insurance; welfare costs of business cycles

JEL Classification: D31, D52, E32, E44, G01, G12, J6