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Microeconomic Origins of Macroeconomic Tail Risks

Author

Listed:
  • Asu Ozdaglar

    (Massachusetts Institute of Technology)

  • Alireza Tahbaz-Salehi

    (Columbia Business School)

  • Daron Acemoglu

    (Massachusetts Institute of Technology)

Abstract

We document that even though the normal distribution is a good approximation to the nature of aggregate fluctuations, it severely underpredicts the frequency of large economic downturns. We then provide a model that can explain these facts simultaneously. Our model shows that the propagation of microeconomic shocks through input-output linkages can fundamentally reshape the distribution of aggregate output, increasing the likelihood of large downturns (macroeconomic tail risks) from infinitesimal to substantial. For example, an economy subject to thin-tailed micro shocks but with "unbalanced" input-output linkages (where some sectors or firms play a much more important role than others as inputs suppliers to the rest of the economy) may exhibit deep recessions as frequently as economies that are subject to heavy-tailed shocks. This is despite the fact that a central limit theorem-type result would imply that aggregate output is normally distributed. We characterize what types of input-output linkages and distributions of microeconomic shocks lead to sizable macroeconomic tail risks, and also show how the same economic forces cause the output of many sectors to simultaneously fall by large amounts.

Suggested Citation

  • Asu Ozdaglar & Alireza Tahbaz-Salehi & Daron Acemoglu, 2015. "Microeconomic Origins of Macroeconomic Tail Risks," 2015 Meeting Papers 314, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:314
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • C67 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Input-Output Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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