Macroeconomic Asymmetries and The Welfare Cost of Business Cycles

I investigate the welfare cost of business cycles due to asymmetries generated by two occasionally binding constraints (OBCs): downward nominal wage rigidity (DNWR) and zero lower bound (ZLB). Although business cycle volatility has declined recently as the Great Moderation literature suggests, I find that the welfare cost of business cycles has significantly increased due to the increased skewness of business cycles over time that is apparent in the data. In a quantitative dynamic equilibrium model that accounts for volatility and skewness changes in pre and post-Volcker periods, I estimate that the welfare cost of business cycles has increased from 0.23% (in terms of consumption equivalence) in the pre-Volcker period to 1.01% in the post-Volcker period, which would be 0.06% in the absence of asymmetry. Counterfactual analysis shows that while both OBCs play a role, the binding ZLB explains most of the welfare effects in the post-Volcker period. Policy counterfactuals indicate that increasing the inflation target from 2% to 4% reduces the skewness of business cycles and the binding rates of both OBCs, thereby leading to a significant decrease in the welfare cost, from 1.01% to 0.74%