welfare cost of business cycles when markets are incomplete

This paper analyzes the welfare effects of business cycles when workers face uninsurable idiosyncratic labor income risk that has a cyclical component. In accordance with the recent literature, this paper assumes that eliminating business cycles amounts to integrating out aggregate shocks (the integration principle) and that idiosyncratic shocks and aggregate shocks are stochastically independent (the independence assumption). This paper provides two arguments why the previous literature has underestimated the welfare costs of business cycles. First, the welfare cost of business cycles are in general indeterminate, and the previous literature has only reported the lower bound that is consistent with the data. In a simple example calibrated to match the observed cyclical variations in displacement probabilities, the lower bound is .35 percent of average consumption and the upper bound is 1.39 percent (using log-utility). Second, the previous literature has only focused on cyclical variations in job displacement (unemployment) probabilities, but neglected cyclical variations in the average income loss of displaced workers. In a simple calibrated example, the introduction of cyclical variations in the average income loss of displaced workers increases the lower bound from .35 percent of average consumption to .94 percent and the upper bound from 1.39 percent to 1.89 percent (again for log-utility)welfare cost of business cycles, incomplete markets

Quitting and labor turnover : microeconomic evidence and macroeconomic consequences

Combining microeconomic evidence with macroeconomic theory, the authors present an integrated approach to wage and employment determination in an economy where firms pay above market"efficiency wages"to prevent trained workers from quitting. The model offers predictions about the behavior of formal employment, labor turnover, and segmentation in response to formal sector productivity shocks (including economic growth and tax reductions), changes in the desirability of self-employment (formal sector tax rates), and the cost of training a new worker. They use panel data from Mexican labor surveys to estimate the quit function derived fromthe model and the results support their view that transitions from formal salaried work to informal self-employment are quits rather than fires. (Quitting is positively related to the mean self-employment income and the probability of being rehired and negatively related to the mean formal salaried wage.) They then use the parameters estimated from the quit function to calibrate the model economy and simulate the impacts of economic shocks and policy innovations and find the impact on employment, turnover, and segmentation to be substantial.Environmental Economics&Policies,Public Health Promotion,Labor Policies,Economic Theory&Research,Labor Management and Relations,Health Monitoring&Evaluation,Banks&Banking Reform,Environmental Economics&Policies,Economic Theory&Research,Labor Management and Relations

Non-existence of recursive equilibria on compact state spaces when markets are incomplete

This paper analyzes one-good exchange economies with two infinitely-lived agents and incomplete markets. It is shown that there are no recursive (Markov) equilibria for which borrowing (debt) constraints never bind if the state space of exogenous and endogenous variables is a compact subset of Rn. Moreover, for large enough (but finite) borrowing limits, no recursive equilibrium with compact state space exists. These non-existence results hold for any economy satisfying the following standard assumptions: preferences are additively separable across time and states; the one-period utility function is time- and state-independent and unbounded from below; endowments are bounded and follow a Markov chain (finite support) with stationary transition matrix; there is some idiosyncratic risk and no aggregate risk. The same non-existence results hold for any number of agents if in addition the marginal utility functions of all agents are convex. Finally, non-existence holds for any number of agents and any Markov endowment chain (with or without aggregate risk) if all agents have identical utility functions of the CRRA-type (homothetic preferences) with degree of relative risk aversion greater than or equal to one

Welfare costs of business cycles when markets are incomplete

This paper analyzes the welfare costs of business cycles when workers face uninsurable idiosyncratic labor income risk. In accordance with the previous literature, this paper decomposes labor income risk into an aggregate and an idiosyncratic component, but in contrast to the previous literature, this paper allows for multiple sources of idiosyncratic labor income risk. Using the multi-dimensional approach to idiosyncratic risk, this paper provides a general characterization of the welfare cost of business cycles when preferences and the (marginal) process of individual labor income in the economy with business cycles are given. The general analysis shows that the introduction of multiple sources of idiosyncratic risk never decreases the welfare cost of business cycles, and strictly increases it if there are cyclical fluctuations across the different sources of risk. Finally, this paper also provides a quantitative analysis of multi-dimensional labor income risk based on a version of the model that is calibrated to match U.S. labor market data. The quantitative analysis suggests that realistic variations across two particular dimensions of idiosyncratic labor income risk increase the welfare cost of business cycles by a substantial amount

Recursive equilibrium in endogenous growth models with incomplete markets

This paper analyzes the existence of recursive equilibria in a class of convex growth models with incomplete markets. Households have identical CRRA-preferences, production displays constant returns to scale with respect to physical and human capital, and all markets are competitive. There are aggregate productivity shocks that affect the aggregate returns to physical and human capital investment (stock returns and wages), and there are idiosyncratic shocks to human capital (idiosyncratic depreciation shocks) that only affect individual human capital returns. For a given history of aggregate shocks, these idiosyncratic human capital shocks are independently distributed over time and identically distributed across agents. Finally, households have the opportunity to trade assets in zero net supply with payoffs that depend on the aggregate shock, but markets are incomplete in the sense that there are no assets with payoffs depending on idiosyncratic shocks. It is shown that there exist recursive equilibria that are simple in the sense that equilibrium prices (returns) only depend on exogenous shocks. Moreover, the allocations associated with simple recursive equilibria are identical to the equilibrium allocations of an economy in which households live in autarky and face both aggregate and idiosyncratic risk