On the Welfare Costs of Consumption Uncertainty

32 Pages Posted: 22 Dec 2006  

Robert J. Barro

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: December 2006

Abstract

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

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

Robert J. Barro (Contact Author)

National Bureau of Economic Research (NBER)

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Harvard University - Department of Economics ( email )

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617-495-3203 (Phone)

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