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Aggregation, Persistence and Volatility in a Macromodel

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  • Karim Abadir
  • Gabriel Talmain

Abstract

This paper shows that aggregation over heterogeneous firms, which are subject to temporary technology shocks, will lead to long memory and nonlinearities. We start from microfoundations, using standard RBC model of monopolistic competition. We then derive the fundamental intertemporal equilibrium path of the economy, and study analytically the time series properties of GDP. We show that the resulting stochastic process is radically different from the process followed by the firms' productivities, which are conventional dynamically-stable autoregressive (AR) processes. This new process is nonlinear, more persistent than any stable AR and yet is mean-reverting (unlike unit-root processes). Its volatility is of a greater order of magnitude than that of any of its components. This amplicfication of volatility means that even small shocks at the micro level can lead to large fluctuations at the macro level. The process is also characterized by long cycles which have random lengths and which are asymmetric. Increased monopoly power will tend to reduce the amplitude and increase the persistence of business cycles.

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Bibliographic Info

Paper provided by Department of Economics, University of York in its series Discussion Papers with number 01/03.

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Handle: RePEc:yor:yorken:01/03

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Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
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Web page: http://www.york.ac.uk/economics/
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Keywords: Autoregressive (AR) process; Autocovariance functions; Autocorrelation functions; Heterogeneous (non-representative) firms; Long memory processes; Monopolistic Competition; Real Business Cycle (RBC).;

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