Volatility, Growth, and Welfare

FRB of St. Louis Working Paper No. 2006-032D

28 Pages Posted: 1 Nov 2008 Last revised: 17 Mar 2011

See all articles by Pengfei Wang

Pengfei Wang

Peking University HSBC Business School

Yi Wen

Federal Reserve Bank of St. Louis - Research Department; Tsinghua University

Date Written: January 2011

Abstract

This paper constructs an endogenous growth model driven by self-fulfilling expectation shocks to explain the stylized fact that the average growth rate of GDP is related negatively to volatility and positively to capacity utilization. The implied welfare gain from further stabilizing the U.S. economy is about a quarter of annual consumption, which is consistent in order of magnitude with estimates based on the empirical studies of Ramey and Ramey (1995) and Alvarez and Jermann (2004). Hence, policies designed to reduce fluctuations can generate large welfare gains because smaller fluctuations are associated with permanently higher rates of growth.

Keywords: Endogenous Growth, Welfare Cost of Business Cycle, Stabilization Policy, Sunspots, Imperfect Competition, Coordination Failures

JEL Classification: E12, E32, O40

Suggested Citation

Wang, Pengfei and Wen, Yi, Volatility, Growth, and Welfare (January 2011). FRB of St. Louis Working Paper No. 2006-032D, Available at SSRN: https://ssrn.com/abstract=1292335 or http://dx.doi.org/10.2139/ssrn.1292335

Pengfei Wang

Peking University HSBC Business School ( email )

Yi Wen (Contact Author)

Federal Reserve Bank of St. Louis - Research Department ( email )

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Saint Louis, MO 63011
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Tsinghua University ( email )

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China