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The welfare cost of structural uncertainty

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Frame of Image ting consumption fluctuations over the business cycles. The structure that generates the consumption fluctuation may be even unknown; thus, the unknown structure may bring in additional welfare costs. This paper derives the welfare measure under the Epstein-Zin preference as well as under the CRRA preference and expresses them in terms of the moment-generating function. In addition, it considers the structural uncertainty in the consumption fluctuation in comparison with a known-fixed structure and analyzes how much the structural uncertainty may contribute to welfare costs. Based on calibration exercises, it shows that consumption fluctuations may entail nontrivial welfare costs and incorporating the structural uncertainty into the data generating process may bring in bigger welfare costs.
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1. Introduction Consumption fluctuation may entail welfare costs for risk-averse consumers; thus, stabilization policy may be sought over the business cycles. The structure that generates the fluctuation may be even unknown, which may bring in additional welfare costs. This paper analyzes the quantitative role of structural uncertainty in its effect on welfare costs in comparison with a known-fixed structure underlying the fluctuation. Changes in economic conditions or policies may affect the consumption welfare. It may be worthwhile to analyze how much should be compensated in consumption dimension in order to attain the same level of welfare against changes in economic conditions or po


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Title The welfare cost of structural uncertainty
Similar Titles
Material Type Report
Author(English)

Kim, Young Il

Publisher

Seoul : Korea Development Institute

Date 2013-08
Pages 18
Subject Country South Korea(Asia and Pacific)
Language English
File Type Documents
Original Format pdf
Subject Economy < General
Economy < Financial Policy
Holding KDI; KDI School of Public Policy and Management
License

Abstract

It may be of interest to analyze how much of welfare gains may be achieved by mitigating consumption fluctuations over the business cycles. The structure that generates the consumption fluctuation may be even unknown; thus, the unknown structure may bring in additional welfare costs. This paper derives the welfare measure under the Epstein-Zin preference as well as under the CRRA preference and expresses them in terms of the moment-generating function. In addition, it considers the structural uncertainty in the consumption fluctuation in comparison with a known-fixed structure and analyzes how much the structural uncertainty may contribute to welfare costs. Based on calibration exercises, it shows that consumption fluctuations may entail nontrivial welfare costs and incorporating the structural uncertainty into the data generating process may bring in bigger welfare costs.

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