On the Welfare Cost of Business Cycles in Developing Countries

Abstract

Economic fluctuations are much stronger in developing countries than in the United States. Yet, while a large literature debates what constitutes a reasonable estimate of the welfare cost of business cycles in the US, it remains an open question how large that cost is in developing countries. Using several model economies, we provide such a measure for a large number of low--income countries. Our first main result is that the welfare cost of consumption volatility per se is far from trivial in those countries, and always averages a substantial multiple of the corresponding estimate for the US. Our second major result is that, in many poor countries, the welfare gain from eliminating that volatility may in fact exceed the welfare gain from an additional 1 percentage point of growth in perpetuity.