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IS IGNORANCE BLISS? THE COST OF BUSINESS-CYCLE UNCERTAINTY

Published online by Cambridge University Press:  14 November 2011

Frode Brevik  and
Stefano d'Addona
Frode Brevik
Affiliation:
VU University Amsterdam
Stefano d'Addona*
Affiliation:
University of Rome 3
*
Address correspondence to: Stefano d'Addona, Department of International Studies, University of Rome 3, Via G. Chiabrera, 199, I-00145 Rome, Italy; e-mail: [email protected].
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Abstract

We investigate the cost of business-cycle uncertainty (lack of firm knowledge about the prevailing state of the economy) in a setup where the economy switches between booms and recessions at random intervals. Calibrating an exchange economy model to match the properties of the postwar U.S. data, we find that giving consumers additional information beyond that already contained in the endowment growth rates yields only moderate gains. In a second stage, we investigate the effect of nonperfect information processing in this setting. Surprisingly, we find that opting for slow learning might yield large utility gains, especially for consumers with a strong preference for early resolution of uncertainty.

Keywords

Business-Cycle UncertaintyEpstein–Zin PreferencesRegime SwitchingLearning
Type
Articles
Information
Macroeconomic Dynamics , Volume 17 , Issue 4 , June 2013 , pp. 728 - 746
Copyright
Copyright © Cambridge University Press 2011 

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