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Short-run fluctuations and long-run growth with recursive preferences

Published online by Cambridge University Press:  27 September 2024

Barbara Annicchiarico ,
Alessandra Pelloni  and
Fabrizio Valenti
Barbara Annicchiarico
Affiliation:
Department of Law, Roma Tre University, Roma, Italy
Alessandra Pelloni*
Affiliation:
Department of Economics and Finance, University of Rome Tor Vergata, Roma, Italy
Fabrizio Valenti
Affiliation:
KSAR Consulting Group, Ottawa, Canada
*
Corresponding author: Alessandra Pelloni; Email: [email protected]
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Abstract

What is the relationship between short-run fluctuations in economic activity and the long-run evolution of the economy? There is empirical evidence that more perturbed economies tend to grow less. Yet matching this evidence has proven challenging for growth models without market failures. This paper examines the relationship between short-term fluctuations and long-term growth within a complete-market economy featuring Epstein-Zin preferences and unbounded growth driven by human and physical capital accumulation. With these preferences, risk aversion and intertemporal elasticity of substitution are allowed to be independent of each other. When the model is plausibly calibrated, the relationship between the mean and variance of growth turns out to be negative. In most cases, the effect of fluctuations on welfare is found to be negative and sizable, even when the long-run effect on growth is positive.

Keywords

Volatility and growthEpstein-Zin preferencesintertemporal elasticity of substitutionrisk aversionD92E22E32O49
Type
Notes
Information
Macroeconomic Dynamics , Volume 29 , 2025 , e39
Copyright
© The Author(s), 2024. Published by Cambridge University Press

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Footnotes

We are very grateful to an anonymous referee and to the associate editor for their useful comments. We thank the participants who attended the presentations at the Freie Universität Berlin, at the Royal Economic Society Annual Conference, Manchester, at the Economic Growth and Macroeconomics Workshop, OFCE, SKEMA, NC State University, Sophia Antipolis, and at the 2nd FGN International Conference - University of Saint Gallen for helpful comments. We are also grateful to Giacomo Corneo, Fabio Di Dio, Francesca Diluiso, Ulrich C. Schneider, Thanasis Stengos, Guido Traficante, and Robert J. Waldmann for useful discussions.

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