Working Paper: CEPR ID: DP7468
Authors: Wouter J. Den Haan; Petr Sedlacek
Abstract: Fluctuations in firms' revenues reduce firms' viability and are costly from a social welfare point of view even when agents are risk neutral if (i) the decision to continue operating a firm is not efficient at the margin so that fluctuations shorten firms' life expectancy (because they increase the chance revenue levels are such that discontinuation is unavoidable) and (ii) the shortening of the life expectancy reduces entry. Welfare consequences are large, even for moderate fluctuations: Implied estimates for the per period costs of business cycles can easily be equal to several percentage points of GDP. These estimates are based on a direct measurement of cyclical changes in the value added generated by workers that recently were not employed. This extensive margin measure of the cyclical change in output is of independent interest.
Keywords: business cycles; frictions
JEL Codes: E24; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fluctuations in firms' revenues (E32) | Inefficient employment decisions (J63) |
| Inefficient employment decisions (J63) | Reduction in average output (E23) |
| Fluctuations (E32) | Shortened expected lifespan of firms (D25) |
| Shortened expected lifespan of firms (D25) | Increased likelihood of discontinuation (C42) |
| Fluctuations (E32) | Deterrence of entry decisions (L11) |
| Entry costs (L11) | Prevention of potentially profitable projects (H43) |
| Costs of business cycles (E32) | Permanent drop in output (E23) |
| Fluctuations (E32) | Inefficiencies in labor market (J49) |