On measuring the welfare cost of business cycles

Lucas (Models of Business Cycles, Basil Blackwell, New York, 1987) argues that the gain from eliminating aggregate fluctuations is trivial. However, a number of researchers have altered assumptions on preferences and found that the gain from eliminating business cycles is potentially very large. This paper estimates the welfare cost of business cycles, allowing for potential time-non-separabilities in preferences, where discipline is placed on the choice of preference parameters by requiring that preferences be consistent with observed fluctuations in a general equilibrium model of business cycles. The estimates of the non-separability parameters are very different than the forms used elsewhere, leading to a small welfare cost of business cycles. (C) 2001 Published by Elsevier Science B.V.