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The Great Diversification?

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  • Vasco Carvalho
  • X. Gabaix

Abstract

We investigate the hypothesis that macroeconomic fluctuations are primitively the results of many microeconomic shocks, and show that it has significant explanatory power for the evolution of macroeconomic volatility. We define fundamental volatility as the volatility that would arise from an economy made entirely of idiosyncratic microeconomic shocks, occurring primitively at the level of sectors or firms. In its empirical construction, motivated by a simple model, the sales share of different sectors vary over time (in a way we directly measure), while the volatility of those sectors remains constant. We find that fundamental volatility accounts for the swings in macroeconomic volatility in the US and the other major world economies in the past half century. It accounts for the great moderation and its undoing. Controlling for our measure of fundamental volatility, there is no break in output volatility. The initial great moderation is due to a decreasing share of manufacturing between 1975 and 1985. The recent rise of macroeconomic volatility is due to the increase of the size of the financial sector. We provide a model to think quantitatively about the large comovement generated by idiosyncratic shocks. As the origin of aggregate shocks can be traced to identifiable microeconomic shocks, we may better understand the origins of aggregate fluctuations.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 422.

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Date of creation: Jan 2010
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Handle: RePEc:bge:wpaper:422

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References

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  1. Jordi Gali & Luca Gambetti, 2008. "On the Sources of the Great Moderation," NBER Working Papers 14171, National Bureau of Economic Research, Inc.
  2. Xavier Gabaix, 2011. "The Granular Origins of Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 79(3), pages 733-772, 05.
  3. Andrei A. Levchenko & Julian di Giovanni, 2009. "International Trade and Aggregate Fluctuations in Granular Economies," 2009 Meeting Papers, Society for Economic Dynamics 491, Society for Economic Dynamics.
  4. Andrew T. Foerster & Pierre-Daniel G. Sarte & Mark W. Watson, 2011. "Sectoral versus Aggregate Shocks: A Structural Factor Analysis of Industrial Production," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 119(1), pages 1 - 38.
  5. Zhongjun Qu & Pierre Perron, 2007. "Estimating and Testing Structural Changes in Multivariate Regressions," Econometrica, Econometric Society, Econometric Society, vol. 75(2), pages 459-502, 03.
  6. Nir Jaimovich & Henry E. Siu, 2007. "The young, the old, and the restless: demographics and business cycle volatility," Staff Report, Federal Reserve Bank of Minneapolis 387, Federal Reserve Bank of Minneapolis.
  7. Vasco M Carvalho, 2008. "Aggregate Fluctuations and the Network Structure of Intersectoral Trade," 2008 Meeting Papers 1062, Society for Economic Dynamics.
  8. Alejandro Justiniano & Giorgio E. Primiceri, 2006. "The Time Varying Volatility of Macroeconomic Fluctuations," NBER Working Papers 12022, National Bureau of Economic Research, Inc.
  9. Xavier Gabaix, 1999. "Zipf'S Law For Cities: An Explanation," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(3), pages 739-767, August.
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Cited by:
  1. Giuseppe Berlingieri, 2013. "Outsourcing and the rise in services," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 51532, London School of Economics and Political Science, LSE Library.
  2. Bryan Kelly & Hanno Lustig & Stijn Van Nieuwerburgh, 2013. "Firm Volatility in Granular Networks," NBER Working Papers 19466, National Bureau of Economic Research, Inc.
  3. Berthold Herrendorf & Richard Rogerson & Ákos Valentinyi, 2013. "Growth and Structural Transformation," NBER Working Papers 18996, National Bureau of Economic Research, Inc.
  4. Julian di Giovanni & Andrei A. Levchenko & Isabelle Méjean, 2013. "Firms, destinations, and aggregate fluctuations," Economics Working Papers 1387, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2014.
  5. Cristiano Cantore & Filippo Ferroni & Miguel A. León-Ledesma, 2012. "The dynamics of hours worked and technology," Banco de Espa�a Working Papers 1238, Banco de Espa�a.
  6. Baran Doda, 2012. "Evidence on CO2 emissions and business cycles," Grantham Research Institute on Climate Change and the Environment Working Papers, Grantham Research Institute on Climate Change and the Environment 78, Grantham Research Institute on Climate Change and the Environment.
  7. Constant Lonkeng Ngouana, 2013. "Structural Transformation and the Volatility of Aggregate Output in OECD Countries," IMF Working Papers 13/43, International Monetary Fund.

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