The Term Structure of the Welfare Cost of Uncertainty

The marginal cost of aggregate fluctuations has a term structure that is a simple transformation of the term structures of equity and interest rates. I extract evidence from index option markets to infer a downward-sloping, volatile and procyclical term structure of welfare costs. On average, the gains from greater macroeconomic stability are large, especially in the short run. I estimate that at the margin the elimination of one-year ahead consumption risk is worth around 12 percentage points of additional growth; this number compares to a marginal cost of lifetime uncertainty of 2-3 percentage points. Over time, the term structure of welfare costs varies substantially, predictably and with a volatility that decreases with maturity. These empirical properties of the term structure of welfare costs cannot be easily captured by today's leading dynamic equilibrium models and therefore represent a puzzling piece of evidence with potentially important welfare implications.