On the Welfare Costs of Business Fluctuations in Sweden 1970 - 2007

Abstract: In this study I analyse models for computing the welfare costs of business fluctuations. Lucas’ (1987) model is very simple, as it only considers consumption fluctuations. The model proposed by Galí, Gertler and Lopez-Salido (2007) includes not only consumption fluctuations, but also fluctuations in hours worked. I apply variations of these models on Swedish data for the period 1970 – 2007. I also discuss the realism of these models. I calculate not only average welfare effects over the period, but also welfare effects of individual booms and recessions. I find small welfare effects on average. The simple calculation based on Lucas' (1987) model yields 0.01 percent of consumption, whereas the calculations based on Galís' et al. (2007) model yield between 0.02 and 0.20 percent of consumption, depending on the choice of parameter values and detrendings. However, the effect of individual booms and recessions might be large. In some of my model variations, I find a welfare cost of about 10 percent of yearly consumption for the recession of the 1990s. On the other hand, two of my model variations only give a cost of 2 percent of yearly consumption for the same recession.