Reconsidering the Welfare Costs of BusinessCycles:
Taking Labor Markets Seriously

Master Thesis by Silke Simon
August 11, 2005

Abstract:

The question whether or not business cycle fluctuations lead to welfare losses is of high political relevance since it implies important recommendations for the course of economic policy between interventionism and laissez-faire. In contrast to several other works, I show that in a setting with incomplete labor markets due to search externalities, the welfare costs of business cycles are substantial. Agents are willing to give up as much as 13 to 23% of consumption in order to live in an environment without fluctuations instead of living in an economy with cycles. Thus, high welfare gains can be generated by counter-cyclical economic policy measures.