On the aggregate welfare cost of Great Depression unemployment

The potential benefit of policies that eliminate a small likelihood of economic crises is calculated. An economic crisis is defined as an increase in unemployment of the magnitude observed during the Great Depression. For the U.S., the maximum-likelihood estimate of entering a depression is found to be about once every 83 years. The welfare gain from setting this small probability to zero can range between 1 and 7 percent of annual consumption in perpetuity. For most estimates, more than half of these large gains result from a reduction in individual consumption volatility. ; This paper supersedes Working Paper 03-20.Depressions ; Unemployment

On the welfare gains of eliminating a small likelihood of economic crises: A case for stabilization policies?

In this paper the authors estimate the potential benefit of policies that eliminate a small likelihood of economic crises. They define an economic crisis as a Depression-style collapse of economic activity. For the U.S., based on the observed frequency of Depression-like events, the authors estimate the likelihood of encountering a depression to be about once every 83 years. Even for this small probability of moving into a Depression-like state, the welfare gain from setting it to zero can range between 1 and 7 percent of annual consumption, in perpetuity. These estimates are large in comparison to welfare costs typically found for microeconomic distortions and suggest that there may be a net benefit to policies directed toward preventing economic instability.Depressions

On the welfare gains of reducing the likelihood of economic crises

The authors seek to measure the potential benefit of reducing the likelihood of economic crises (defined as Depression-style collapses of economic activity). Based on the observed frequency of Depression-like events, they estimate this likelihood to be approximately one in every 83 years for the U.S. The welfare gain of reducing even this small probability of crisis to zero can range between 1.05 percent and 6.59 percent of annual consumption in perpetuity. These large gains occur because although the probability of entering a Depression-like state is small, once the state is entered it is highly persistent. The authors also find that for some calibrations of the model, uninsured unemployment risk contributes significantly to the size of the gains.Depressions ; Financial crises ; Business cycles

Still Very Preliminary

The authors wish to thank Hal Cole for helpful comments, as well as seminar participants at Iowa, FRB Atlanta, Ohio State, and the Philadelphia Macro Workshop. We also wish to thank When people cannot commit to pay back their loans and there is limited information about their characteristics, lending institutions must draw inferences about their likelihood of default. In this paper, we examine how this inference problem impacts consumption smoothing. In particular, we study an environment populated by two types of people who differ with respect to their rates of time preference and receive idiosyncratic earnings shocks. Impatient types are more likely to borrow and default than patient types. Lenders cannot directly observe a person’s type but make probabilistic assessments of it based on the person’s credit history. The model delivers an integrated theory of terms of credit and credit scoring that seems broadly consistent with the data. We also examine the impact of legal restrictions on the length of time adverse events can remain on one’s credit record for consumption The legal environment surrounding the U.S. unsecured consumer credit market is characterize

Financial Fragility and the Great Depression

We analyze a financial collapse, such as the one which occurred during the Great Depression, from the perspective of a monetary model with multiple equilibria. The economy we consider contains financial fragility due to increasing returns to scale in the intermediation process. Intermediaries provide the link between savers and firms who require working capital for production. Fluctuations in the intermediation process are driven by variations in the confidence agents place in the financial system. Our model matches quite closely the qualitative movements in some financial and real variables (the currency/deposit ratio, ex-post real interest rates, the level of intermediated activity, deflation, employment and production) during the Great Depression period.

On the welfare gains of reducing the likelihood of economic crises.

The authors' aim in this paper is to obtain a measure of the potential benefit of reducing the likelihood of economic crises. The authors define an economic crisis as a Depression-style collapse of economic activity. Based on the observed frequency of Depression-like events, the authors estimate this likelihood to be approximately once every 83 years for the United States. Even for this small probability of moving into a Depression-like state, the welfare gain from setting it to zero can range between 1.05 percent and 6.59 percent of annual consumption, in perpetuity. These large gains arise because even though the probability of encountering a Depression-like state is small, it is highly persistent once it occurs. The authors also find that for some calibrations of the model, uninsured unemployment risk contributes significantly to the size of these gains.Depressions

Competitive theories for economies with general transactions technology

In this paper, the authors describe and compare two approaches to analyzing transactions costs in a general equilibrium setting. In the first approach, which the authors label the transactions costs approach, the commodity space is the same as that used in models without transactions costs. In the second approach, which we label the valuation equilibrium approach, the commodity space is chosen so that the exchange problem can be formulated as an instance of the abstract exchange model described in Debreu (1954). The authors argue that the valuation equilibrium approach provides a tractable framework for quantitative studies of the effects of transactions costs on economy-wide resource allocation.Macroeconomics

A welfare comparison of pre- and post-WWII business cycles: some implications for the role of postwar macroeconomic policies

The authors compute the potential economic benefits that would accrue to a typical pre-WWII era U.S. worker from the post-WWII macroeconomic policy regime. The authors assume that workers face undiversifiable income risk but can self-insure by saving in nominal assets. The worker's average utility is computed for two eras: pre-WWII (1875-1941) and post-WWII. In the pre-WWII era, the worker endured business cycles that were large in amplitude and quite volatile, a procyclical aggregate price level with large cyclical amplitude, a high average unemployment rate, and virtually no trend in the aggregate price level. In the post-WWII era, the same worker would have encountered business cycles with smaller amplitude and less volatility, a countercyclical aggregate price level with small cyclical amplitude, a much lower mean unemployment rate, and a positive trend in the aggregate price level. Depending on what is assumed about the effects of macroeconomic policies on the mean and var iance of the unemployment rate, the potential gain in the worker's welfare ranges between -0.9 (if policies affected the inflation rate but not the mean or variance of the aggregate unemployment rate) to 4.19 percent of consumption (if policies affected the inflation rate and lowered the mean and variance of the aggregate unemployment rate).Business cycles ; Economic history

Monetary and financial forces in the Great Depression

What caused the worldwide collapse in output from 1929 to 1933? Why was the recovery from the trough of 1933 so protracted for the U.S.? How costly was the decline in terms of welfare? Was the decline preventable? These are some of the questions that have motivated economists to study the Great Depression. In this paper, the authors review some of the economic literature that attempts to answer these questions.Depressions