Planning Against Disasters in Dynamic Production Networks

In dynamic multisector economies the planner’s optimal capital allocation can dampen the impact of shocks cascading through nonlinear production networks. In a simple environment, we show analytically that when inputs are complementary and risk aversion is not too low, (i) optimal capital allocation under uncertainty involves deliberately over-investing, relative to the deterministic optimum, in upstream sectors in order to mitigate severe economic downturns; (ii) this strategy can reduce the average level of consumption and give rise to a high welfare cost of business cycles. Deploying novel deep-learning techniques in a general environment, we show quantitatively that: (iii) the ergodic distribution of the simulated nonlinear economy features higher mean capital levels in key upstream sectors, lower mean levels of macroeconomic aggregates, realistic aggregate volatility, and a welfare cost of business cycles nearly 30 times larger when nonlinearities are accounted for.