A QUANTITATIVE DEFENSE OF STABILIZATION POLICY

In an analysis of the value of growth and stabilization of consumption, Robert Lucas (1987) presents a stunning set of calculations implying that a permanent increase in the growth rate of consumption of only one-tenth percentage point per year is worth nearly 50 times as much to consumers as complete elimination of consumption variability. This is because the higher growth of consumption is worth a lot while the reduced variability is worth virtually nothing (at least in the post-war United States). Taken at face value, such a result supports the pursuit of feasible growth policies but calls into serious question the study and practice of macroeconomic stabilization policy even if complete elimination of variance were feasible and costless. Primarily by considering alternative meanings of stabilization that allow an increase in mean consumption, this paper establishes that stabilization can be worth a lot, at least 25 times the value found by Lucas. Further, the paper shows the value of a permanent increase in the growth rate of consumption to be only one-fourth the value in Lucas (although still relatively large), by deriving a modified valuation formula that allows the coefficient of relative risk aversion to exceed unity