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Table 4.4: Welfare Cost of All Macroeconomic Uncertainty (1947-2012) –% Consumption
PANEL A ( 12 6= 0)
Welfare Cost
Marginal Welfare Cost
1 5 10 20 1 5 10 20
0.95 0.26 0.45 0.47 0.40 0.51 0.93 0.98 0.90
0.97 0.46 0.56 0.53 0.44 0.92 1.15 1.11 0.99
0.99 0.90 0.65 0.58 0.46 1.83 1.34 1.22 1.05
PANEL B ( 12 = 0)
Welfare Cost
Marginal Welfare Cost
1 5 10 20 1 5 10 20
0.95 0.13 0.24 0.27 0.29 0.26 0.49 0.55 0.59
0.97 0.22 0.29 0.30 0.30 0.45 0.59 0.61 0.63
0.99 0.44 0.34 0.32 0.31 0.88 0.68 0.66 0.65
Note: 12 is the covariance between " t (permanent shocks) and t (transitory
shocks) de…ned in equation (2.9)
which uses only lagged consumption growth as information set, whereas we …tted a bivariate model,
and found evidence of Granger (1969) causality from income to consumption (a t-statistic of 2.50
for income growth in consumption’s equation). This implies di¤erent results for single equation and
multivariate analyses, and reinforces the importance of the latter, since the consumer ought to look
beyond consumption to form expectations in computing welfare.
Finally, it is worth comparing our marginal welfare costs estimates with those found by Alvarez
and Jermann (2004). For the post-war era, our marginal welfare costs of business cycles are all
negative – our best estimate being 0:07% of consumption. Compare this to the estimates of
marginal welfare costs in Alvarez and Jermann for the period 1954-2001: between 0:08% and 0:49%
of consumption – computed at business-cycle frequencies alone. As we argued above, if one does
not properly disentangle the e¤ects of permanent and transitory shocks to consumption, there is the
risk of biasing the estimate of the welfare costs of business cycles. Although Alvarez and Jermann
try to remedy this problem by using various …lters to isolate gains from eliminating ‡uctuations at
business cycle frequencies, permanent shocks can induce short-term variation in consumption, which
will not be …ltered out by their procedure. So, we should expect an upward bias. Notwithstanding
the slight di¤erence in sample periods in estimation, the marginal welfare costs in their paper are
very di¤erent than ours for the post-war period 11 .
11 Since our sample includes the great recession of 2008, but theirs do not, the fact that they …nd a much larger
estimate is even more problematic.
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