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REVISITING THE W ELFARE EFFECTS OF ELIMINATING BUSINESS CYCLES

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We investigate the welfare effects of eliminating business cycles in a model with substantial consumer heterogeneity. The heterogeneity arises from uninsurable and idiosyncratic un- certainty in preferences and employment status, where we distinguish between short- and long-term unemployment. We calibrate the model to match the distribution of wealth in U.S. data and features of transitions between employment and unemployment. Our analysis takes into account the transition from a steady state with cycles to one without cycles. Un- like previous studies, therefore, we can study how business cycles affect different groups of consumers. We conclude that the cost of cycles is positive but quite small on average. There are, however, large differences across groups: very poor consumers can gain a lot when cycles are removed, as can very rich consumers, whereas the majority of consumers—the "middle class"—sees very small negative effects from removing cycles. Inequality rises substantially upon removing cycles: the Gini coefficient on wealth moves from around 0.8 to 0.9.
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