The Cost of Business Cycles Under Endogenous Growth

50 Pages Posted: 14 Oct 2003

See all articles by Gadi Barlevy

Gadi Barlevy

Federal Reserve Bank of Chicago; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Multiple version iconThere are 2 versions of this paper

Date Written: August 2003

Abstract

In his famous 1987 monograph, Robert Lucas argued that further stabilizing the business cycles that persisted in the post-War era was pointless, because these cycles had a negligible effect on societal well-being. In particular, Lucas demonstrated that society should be willing to pay only a tiny fraction of its consumption expenditures per year to completely eliminate the fluctuations that prevailed over this period. This conclusion has been largely reaffirmed by subsequent studies, and has been commonly cited as evidence that policymakers should abstain from intervening to offset macroeconomic fluctuations of the magnitude that prevailed over this period.

This paper disputes this conclusion and argues that the business cycles that prevailed over this period were costly, and thus opens the door to the possibility that stabilization policy might be desirable after all. It does this by demonstrating that business cycles can have a deleterious effect on the rate at which the economy grows over the long run. The reason is that cycles lead to volatile investment, reducing the efficiency of investment. Essentially, the fact that investment activity is concentrated in booms rather than spread out uniformly over time creates congestion effects that lower the productivity of investment. I estimate that eliminating the cyclical fluctuations that prevailed during the post-War period would have increased the growth rate of real GDP per capita in the U.S. from 2.0% per year to 2.5% per year. The cost of reduced growth from macroeconomic volatility is computed at a rate of 10% of consumption expenditures per year, over 100 times.

Suggested Citation

Barlevy, Gadi, The Cost of Business Cycles Under Endogenous Growth (August 2003). FRB of Chicago Working Paper No. wp2003-13. Available at SSRN: https://ssrn.com/abstract=442382 or http://dx.doi.org/10.2139/ssrn.442382

Gadi Barlevy (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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