IDEAS home Printed from https://ideas.repec.org/p/ecm/nasm04/484.html
   My bibliography  Save this paper

Power laws and the origins of aggregate fluctuations

Author

Listed:
  • Xavier Gabaix

Abstract

If firm sizes have a small dispersion, microeconomic shocks lead to negligible aggregate fluctuations. This has led economists to appeal to macroeconomic (sectoral or aggregate shocks) shocks to explain aggregate fluctuations. However, the empirical distribution of firms is fat-tailed. This paper shows how, in a world with fat-tailed firm size distribution, idiosyncratic fluctuations aggregate up to non-trivial macro fluctuations. We illustrate how this happens, and contend that business cycle shocks come in large part from idiosyncratic shocks to firms. We show empirically that idiosyncratic volatility is indeed large enough to account for GDP volatility. This mechanism could, potentially, explain a large part of the volatility of a variety of aggregate quantities: business cycle fluctuations, inventories, inflation, medium or long run movements in productivity, and the current account

Suggested Citation

  • Xavier Gabaix, 2004. "Power laws and the origins of aggregate fluctuations," Econometric Society 2004 North American Summer Meetings 484, Econometric Society.
    • Handle: RePEc:ecm:nasm04:484
    as

    Download full text from publisher

    File URL: http://econ-www.mit.edu/faculty/download_pdf.php?id=238
    File Function: main text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Miles S. Kimball & John G. Fernald & Susanto Basu, 2006. "Are Technology Improvements Contractionary?," American Economic Review, American Economic Association, vol. 96(5), pages 1418-1448, December.
    2. Bak, Per & Chen, Kan & Scheinkman, Jose & Woodford, Michael, 1993. "Aggregate fluctuations from independent sectoral shocks: self-organized criticality in a model of production and inventory dynamics," Ricerche Economiche, Elsevier, vol. 47(1), pages 3-30, March.
    3. Wyart, Matthieu & Bouchaud, Jean-Philippe, 2003. "Statistical models for company growth," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 326(1), pages 241-255.
    4. Aart Kraay & Jaume Ventura, 2007. "Comparative Advantage and the Cross-section of Business Cycles," Journal of the European Economic Association, MIT Press, vol. 5(6), pages 1300-1333, December.
    5. Charles R. Hulten & Edwin R. Dean & Michael J. Harper, 2001. "New Developments in Productivity Analysis," NBER Books, National Bureau of Economic Research, Inc, number hult01-1, May.
    6. Ricardo J. Caballero & Eduardo M.R.A. Engel, 2003. "Missing Aggregate Dynamics: On the Slow Convergence of Lumpy Adjustment Models," Cowles Foundation Discussion Papers 1430, Cowles Foundation for Research in Economics, Yale University, revised Apr 2008.
    7. Klette, Tor Jakob & Griliches, Zvi, 2000. "Empirical Patterns of Firm Growth and R&D Investment: A Quality Ladder Model Interpretation," Economic Journal, Royal Economic Society, vol. 110(463), pages 363-387, April.
    8. Boyan Jovanovic, 1987. "Micro Shocks and Aggregate Risk," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(2), pages 395-409.
    9. Jonathan Eaton & Samuel Kortum & Francis Kramarz, 2004. "Dissecting Trade: Firms, Industries, and Export Destinations," American Economic Review, American Economic Association, vol. 94(2), pages 150-154, May.
    10. Acemoglu, Daron & Zilibotti, Fabrizio, 1997. "Was Prometheus Unbound by Chance? Risk, Diversification, and Growth," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 709-751, August.
    11. Baumol, William J, 1982. "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, American Economic Association, vol. 72(1), pages 1-15, March.
    12. Steven N. Durlauf, 1993. "Nonergodic Economic Growth," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(2), pages 349-366.
    13. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-283, April.
    14. Youngki Lee & Luis A. N. Amaral & David Canning & Martin Meyer & H. Eugene Stanley, 1998. "Universal features in the growth dynamics of complex organizations," Papers cond-mat/9804100, arXiv.org.
    15. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, December.
    16. Susanto Basu & John Fernald, 2001. "Why Is Productivity Procyclical? Why Do We Care?," NBER Chapters, in: New Developments in Productivity Analysis, pages 225-302, National Bureau of Economic Research, Inc.
    17. L. A. N. Amaral & S. V. Buldyrev & S. Havlin & H. Leschhorn & P. Maass & M. A. Salinger & H. E. Stanley & M. H. R. Stanley, 1997. "Scaling behavior in economics: I. Empirical results for company growth," Papers cond-mat/9702082, arXiv.org.
    18. David S. Scharfstein, 1998. "The Dark Side of Internal Capital Markets II: Evidence from Diversified Conglomerates," NBER Working Papers 6352, National Bureau of Economic Research, Inc.
    19. Gabaix, Xavier & Ioannides, Yannis M., 2004. "The evolution of city size distributions," Handbook of Regional and Urban Economics, in: J. V. Henderson & J. F. Thisse (ed.), Handbook of Regional and Urban Economics, edition 1, volume 4, chapter 53, pages 2341-2378, Elsevier.
    20. James H. Stock & Mark W. Watson, 2003. "Has the Business Cycle Changed and Why?," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 159-230, National Bureau of Economic Research, Inc.
    21. James H. Stock & Mark W. Watson, 2003. "Has the business cycle changed?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 9-56.
    22. Moses Abramovitz, 1956. "Resource and Output Trends in the United States since 1870," NBER Books, National Bureau of Economic Research, Inc, number abra56-1, May.
    23. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
    24. Marianne Bertrand & Antoinette Schoar, 2003. "Managing with Style: The Effect of Managers on Firm Policies," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(4), pages 1169-1208.
    25. Erzo G. J. Luttmer, 2004. "The size distribution of firms in an economy with fixed and entry costs," Working Papers 633, Federal Reserve Bank of Minneapolis.
    26. Allen C. Head, 1995. "Country Size, Aggregate Fluctuations, and International Risk Sharing," Canadian Journal of Economics, Canadian Economics Association, vol. 28(4b), pages 1096-1119, November.
    27. Timothy G. Conley & Bill Dupor, 2003. "A Spatial Analysis of Sectoral Complementarity," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 311-352, April.
    28. Shea, John S, 2002. "Complementarities and Comovements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 412-433, May.
    29. Dupor, Bill, 1999. "Aggregation and irrelevance in multi-sector models," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 391-409, April.
    30. Charles I. Jones, 2005. "The Shape of Production Functions and the Direction of Technical Change," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(2), pages 517-549.
    31. Xavier Gabaix & Parameswaran Gopikrishnan & Vasiliki Plerou & H. Eugene Stanley, 2003. "A theory of power-law distributions in financial market fluctuations," Nature, Nature, vol. 423(6937), pages 267-270, May.
    32. Moses Abramovitz, 1956. "Resource and Output Trends in the United States since 1870," NBER Chapters, in: Resource and Output Trends in the United States since 1870, pages 1-23, National Bureau of Economic Research, Inc.
    33. Diego Comin & Sunil Mulani, 2003. "Diverging Trends in Macro and Micro Volatility: Facts," Macroeconomics 0306008, University Library of Munich, Germany.
    34. Chang-Jin Kim & Charles R. Nelson, 1999. "Has The U.S. Economy Become More Stable? A Bayesian Approach Based On A Markov-Switching Model Of The Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 608-616, November.
    35. Hyun-Han Shin & René M. Stulz, 1998. "Are Internal capital Markets Efficient?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(2), pages 531-552.
    36. Canning, D. & Amaral, L. A. N. & Lee, Y. & Meyer, M. & Stanley, H. E., 1998. "Scaling the volatility of GDP growth rates," Economics Letters, Elsevier, vol. 60(3), pages 335-341, September.
    37. Caballero, Ricardo J & Engel, Eduardo M R A & Haltiwanger, John, 1997. "Aggregate Employment Dynamics: Building from Microeconomic Evidence," American Economic Review, American Economic Association, vol. 87(1), pages 115-137, March.
    38. Horvath, Michael, 2000. "Sectoral shocks and aggregate fluctuations," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 69-106, February.
    39. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
    40. Harberger, Arnold C, 1998. "A Vision of the Growth Process," American Economic Review, American Economic Association, vol. 88(1), pages 1-32, March.
    41. Okuyama, K & Takayasu, M & Takayasu, H, 1999. "Zipf's law in income distribution of companies," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 269(1), pages 125-131.
    42. Diego Comin & Sunil Mulani, 2003. "Diverging Trends in Macro and Micro Volatility: Facts," Macroeconomics 0306008, EconWPA.
    43. Xavier Gabaix, 1999. "Zipf's Law for Cities: An Explanation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(3), pages 739-767.
    44. S. V. Buldyrev & L. A. N. Amaral & S. Havlin & H. Leschhorn & P. Maass & M. A. Salinger & H. E. Stanley & M. H. R. Stanley, 1997. "Scaling behavior in economics: II. Modeling of company growth," Papers cond-mat/9702085, arXiv.org.
    45. Nirei, Makoto, 2006. "Threshold behavior and aggregate fluctuation," Journal of Economic Theory, Elsevier, vol. 127(1), pages 309-322, March.
    46. Michael Horvath, 1998. "Cyclicality and Sectoral Linkages: Aggregate Fluctuations from Independent Sectoral Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(4), pages 781-808, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Gatti, Domenico Delli & Guilmi, Corrado Di & Gaffeo, Edoardo & Giulioni, Gianfranco & Gallegati, Mauro & Palestrini, Antonio, 2005. "A new approach to business fluctuations: heterogeneous interacting agents, scaling laws and financial fragility," Journal of Economic Behavior & Organization, Elsevier, vol. 56(4), pages 489-512, April.
    2. Andrei A. Levchenko, 2005. "Financial Liberalization and Consumption Volatility in Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 52(2), pages 237-259, September.
    3. Domenico Delli Gatti & Edoardo Gaffeo & Mauro Gallegati & Antonio Palestrini, 2005. "The Apprentice Wizard: Montetary Policy, Complexity And Learning," New Mathematics and Natural Computation (NMNC), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 109-128.
    4. Erzo G. J. Luttmer, 2004. "The size distribution of firms in an economy with fixed and entry costs," Working Papers 633, Federal Reserve Bank of Minneapolis.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Xavier Gabaix, 2011. "The Granular Origins of Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(3), pages 733-772, May.
    2. Vasco Carvalho & Xavier Gabaix, 2013. "The Great Diversification and Its Undoing," American Economic Review, American Economic Association, vol. 103(5), pages 1697-1727, August.
    3. Sean Holly & Ivan Petrella, 2008. "Factor demand linkages and the business cycle: interpreting aggregate fluctuations as sectoral fluctuations," CDMA Conference Paper Series 0809, Centre for Dynamic Macroeconomic Analysis.
    4. Vasco Carvalho, 2007. "Aggregate fluctuations and the network structure of intersectoral trade," Economics Working Papers 1206, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2010.
    5. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2010. "Cascades in Networks and Aggregate Volatility," NBER Working Papers 16516, National Bureau of Economic Research, Inc.
    6. Sean Holly & Ivan Petrella, 2012. "Factor Demand Linkages, Technology Shocks, and the Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 94(4), pages 948-963, November.
    7. Xavier Gabaix, 2009. "Power Laws in Economics and Finance," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 255-294, May.
    8. Stanley, H.E. & Gabaix, Xavier & Gopikrishnan, Parameswaran & Plerou, Vasiliki, 2007. "Economic fluctuations and statistical physics: Quantifying extremely rare and less rare events in finance," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 382(1), pages 286-301.
    9. Stanley, H. Eugene & Plerou, Vasiliki & Gabaix, Xavier, 2008. "A statistical physics view of financial fluctuations: Evidence for scaling and universality," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(15), pages 3967-3981.
    10. Hans Gersbach & Jean-Charles Rochet, 2012. "Aggregate Investment Externalities and Macroprudential Regulation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44, pages 73-109, December.
    11. Can Tian, 2014. "Forecast Shocks in Production Networks," 2014 Meeting Papers 87, Society for Economic Dynamics.
    12. Glenn Magerman & Karolien De Bruyne & Emmanuel Dhyne & Jan Van Hove, 2016. "Heterogeneous Firms and the Micro Origins of Aggregate Fluctuations," Working Papers ECARES ECARES 2016-35, ULB -- Universite Libre de Bruxelles.
    13. Hansen, G.D. & Ohanian, L.E., 2016. "Neoclassical Models in Macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2043-2130, Elsevier.
    14. repec:zbw:bofrdp:2015_025 is not listed on IDEAS
    15. Stefano Costa & Federico Sallusti & Claudio Vicarelli, 2022. "Trade networks and shock transmission capacity: a new taxonomy of Italian industries," Economia e Politica Industriale: Journal of Industrial and Business Economics, Springer;Associazione Amici di Economia e Politica Industriale, vol. 49(1), pages 133-153, March.
    16. Yukiko Saito & Makoto Nirei & Vasco Carvalho, 2014. "Supply Chain Disruptions: Evidence from Great East Japan Earthquake," 2014 Meeting Papers 595, Society for Economic Dynamics.
    17. F. Owen Irvine & Scott Schuh, 2007. "The roles of comovement and inventory investment in the reduction of output volatility," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
    18. Neusser, Klaus, 2008. "Interdependencies of US manufacturing sectoral TFPs: A spatial VAR approach," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 991-1004, September.
    19. Dong, Feng & Wen, Yi, 2019. "Long and Plosser meet Bewley and Lucas," Journal of Monetary Economics, Elsevier, vol. 102(C), pages 70-92.
    20. Lorenzo Burlon, 2012. "How Do Aggregate Fluctuations Depend on the Network Structure of the Economy?," Working Papers in Economics 278, Universitat de Barcelona. Espai de Recerca en Economia.
    21. repec:zbw:bofrdp:urn:nbn:fi:bof-201512101464 is not listed on IDEAS
    22. Shaowen Luo, 2020. "Propagation of Financial Shocks in an Input-Output Economy with Trade and Financial Linkages of Firms," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 36, pages 246-269, April.

    More about this item

    Keywords

    idiosyncratic shocks; aggregate fluctuations; power laws; fat tails; macroeconomic fluctuations;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecm:nasm04:484. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Christopher F. Baum (email available below). General contact details of provider: https://edirc.repec.org/data/essssea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.