On the Distribution of the Welfare Losses of Large Recessions

How big are the welfare losses from severe economic downturns, such as the Great Recession the U.S. experienced in recent years? How are those losses dis- tributed across the population? In this paper we answer these questions using a canonical business-cycle model featuring household income and wealth hetero- geneity that matches micro data from the Panel Study of Income Dynamics (PSID). We document how these losses are distributed across households and how they are affected by social insurance policies. We find the welfare cost of losing one’s job in a Great Recession ranges from 2% of lifetime consumption for the wealthiest households to 5% for low wealth households. The cost increases to approximately 8% for low wealth households if unemployment insurance benefits are cut from 50% to 10%. The fact that welfare losses fall with wealth, and that in our model (as in the data) a large fraction of households has very low wealth, implies that the impact of a severe recession, once aggregated across all households, is very significant (2.2% of lifetime consumption).