Endogenous volatility, endogenous growth, and large welfare gains from stabilization policies

Abstract

This paper shows that (i) fluctuations driven by self-fulfilling expectations can negatively affect long-run growth and (ii) the welfare gain from further stabilizing the U.S. economy can be several orders larger than that calculated by Lucas (1987) because policies designed to reduce fluctuations can generate permanently higher rates of growth. Self fulfilling expectations arise from incomplete information for price setting firms. ; Previously titled: Volatility, growth, and large welfare gains from stabilization policies