I would like to ask a question about the magnitude of the welfare effect of a policy.
When I calculate the short-run percentage decrease of steady-state consumption which makes the household indifferent between implementing and not implementing a product market reform in my model, I find this value to be about 30%.
This seems unusually high to me (most of the welfare loss values I have come across are below 5%). In addition, I find that this result is driven by the addition of a ‘disutility of labour’ term (chi*(1-u_SS)^2/2) into a utility function of the form log(c). In the absence of this disutility term, the short-run welfare loss is about 3%. This terms reduces the value of the period utility function enough to create this effect.
I wanted to ask for your opinion on whether this result makes sense? Many thanks
The result of this is that the short-run consumption loss from implementing the policy is 30% of steady-state consumption in the model with the disutility term (and about 3% in the model without).
The explanation for this appears to be that in the utility = log(c) - chi*(1-u)^2/2 model, unemployment falls by about 1.1 percentage points in the short-run (12 quarters from implementation of the policy). This fall in unemployment affects welfare (an effect which is absent with log (c) utility).
I just wonder whether the consumption loss when a disutility term is included in the utility function is incredible. It seems like quite a large difference owing only to the effect of unemployment.
If all your computations are correct, then this is a feature of your economic model. I find the number a bit too high, but I am not surprised that a policy that stabilizes employment might have bigger welfare effects if unemployment is considered. Of course, results will very much depend on the weight chi you give to employment.