Revisiting the welfare costs of consumption fluctuations and reduced growth: What matters most to consumers?

Abstract

In an influential work, Lucas (1987) concluded that the welfare benefits of long-term consumption growth far outweigh those of eliminating consumption fluctuation, interpreting this as evidence of the success of the short-term macroeconomics field. We revisit these conclusions to examine their robustness to more plausible variations in long-term consumption growth and the inclusion of habit formation. We also introduce a novel measure to quantify the welfare cost of business cycles, where consumer compensation occurs through a higher consumption growth rate rather than in the level. In the United States economy, the welfare cost of reducing growth is sensitive to alternative consumption growth rates; however, the evidence still supports the argument that growth matters more for consumers than deeper stability. Regarding the welfare cost of business cycles, our results reveal that compensation through higher consumption levels costs less.