Variable Effort, Business Cycles, and Economic Welfare

Abstract

Recent literature has shown that productivity-driven business cycles are beneficial to consumers in the context of market clearing real business cycle model. In this paper, we argue that this notion of welfare-improving business cycles does not jointly satisfy (1) the balanced growth path property and (2) micro evidence on the Frisch labor supply elasticity. We then show that once “variable effort,” a channel that plays an important role in the business cycle frequency but has been ignored by the previous literature on the welfare cost of business cycles, is introduced into the model, welfare-improving business cycles can be achieved in relatively plausible parameter regions.