DP12384 The Welfare and Distributional Effects of Fiscal Volatility: a Quantitative Evaluation

Author(s): Rüdiger Bachmann, Jinhui Bai, Minjoon Lee, Fudong Zhang
Publication Date: October 2017
Keyword(s): Distributional Effects, fiscal volatility, labor income risk, transition path, Wealth Inequality, Welfare costs
JEL(s): E30, E32, E60, E62, H30
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12384

This study explores the welfare and distributional effects of fiscal volatility using a neoclassical stochastic growth model with incomplete markets. In our model, households face uninsurable idiosyncratic risks in their labor income and discount factor processes, and we allow aggregate uncertainty to arise from both productivity and government purchases shocks. We calibrate our model to key features of the U.S. economy, before eliminating government purchases shocks. We then evaluate the distributional consequences of the elimination of fiscal volatility and find that, in our baseline case, welfare gains increase with private wealth holdings.