A Utility-Based Welfare Criterion in a Model with Endogenous Capital Accumulation

Abstract

This paper extends the utility-based welfare criterion developed by Rotemberg and Woodford (1997) and Woodford (2003) to a model with endogenous capital accumulation. The welfare criterion obtained for this model shares several features with the corresponding expressions that have been derived in simpler models without capital accumulation. In particular, a criterion can be specified such that welfare losses depend solely on quadratic functions of the model's variables, thus confirming that policy should be oriented toward stabilization of macroeconomic aggregates, rather than toward attaining particular levels of those aggregates. That said, an important difference that obtains in this case is that the composition of output directly affects welfare in the endogenous-capital model--a result that is not present in standard treatments.