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Power laws and the origins of aggregate fluctuations

  • Xavier Gabaix

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

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 484.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:484
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