32 Pages Posted: 22 Dec 2006
Date Written: December 2006
Satisfactory calculations of the welfare cost of aggregate consumption uncertainty require a framework that replicates major features of asset prices and returns, such as the high equity premium and low risk-free rate. A Lucas-tree model with rare but large disasters is such a framework. In a baseline simulation, the welfare cost of disaster risk is large -- society would be willing to lower real GDP by about 20% each year to eliminate all disaster risk, including wars. In contrast, the welfare cost from usual economic fluctuations is much smaller, though still important -- corresponding to lowering GDP by around 1.5% each year.
Suggested Citation: Suggested Citation
Barro, Robert J., On the Welfare Costs of Consumption Uncertainty (December 2006). NBER Working Paper No. w12763. Available at SSRN: https://ssrn.com/abstract=951919