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The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten's Theorem

Author

Listed:
  • Emmanuel Farhi

    (Harvard University)

  • David Baqaee

    (London School of Economics and Political)

Abstract

We provide a nonlinear characterization of the macroeconomic impact of microeconomic TFP shocks in terms of reduced-form non-parametric elasticities for efficient economies. We also provide the mapping from structural parameters to these reduced-form elasticities, under general equilibrium. In this sense, the paper extends the foundational theorem of Hulten (1978) beyond first-order terms to capture nonlinearities. Key features ignored by first-order approximations that play a crucial role are: structural elasticities of substitution, network linkages, structural returns to scale, and the degree to which factors can be reallocated. Higher-order terms are large and economically interesting: they magnify negative shocks and attenuate positive shocks, resulting in an output distribution that is asymmetric (negative skewness), fat-tailed (excess kurtosis), and has a lower mean. They explain how small microeconomic shocks to critical sectors can have a large macroeconomic impact. To give a sense of magnitudes: in our benchmark calibration, output losses due to business cycle fluctuations are 0.6% of GDP, an order of magnitude larger than the cost of business cycles calculated by Lucas (1987), and are entirely due to a reduction in the mean of GDP because of nonlinearities in production; and accounting for second-order terms increases the estimated impact of the price shock to the critical sector of oil in the 1970s from 0.7% to 2.4% of world GDP.

Suggested Citation

  • Emmanuel Farhi & David Baqaee, 2017. "The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten's Theorem," 2017 Meeting Papers 479, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:479
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    Cited by:

    1. Joseph Steinberg, 2018. "International Portfolio Diversification and the Structure of Global Production," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 195-219, July.
    2. Michael Weber & Ali Ozdagli, 2016. "Monetary Policy Through Production Networks: Evidence from the Stock Market," 2016 Meeting Papers 148, Society for Economic Dynamics.
    3. Galeotti, A. & Golub, B. & Goyal, S., 2017. "Targeting Interventions in Networks," Cambridge Working Papers in Economics 1744, Faculty of Economics, University of Cambridge.
    4. Ernesto Pasten & Raphael Schoenle & Michael Weber, 2017. "Price Rigidities and the Granular Origins of Aggregate Fluctuations," NBER Working Papers 23750, National Bureau of Economic Research, Inc.
    5. Jan De Loecker & Jan Eeckhout, 2017. "The Rise of Market Power and the Macroeconomic Implications," NBER Working Papers 23687, National Bureau of Economic Research, Inc.
    6. David Rezza Baqaee & Emmanuel Farhi, 2017. "Productivity and Misallocation in General Equilibrium," NBER Working Papers 24007, National Bureau of Economic Research, Inc.
    7. Lorenzo Caliendo & Fernando Parro & Aleh Tsyvinski, 2017. "Distortions and the Structure of the World Economy," NBER Working Papers 23332, National Bureau of Economic Research, Inc.
    8. Daron Acemoglu & Pablo D. Azar, 2017. "Endogenous Production Networks," NBER Working Papers 24116, National Bureau of Economic Research, Inc.
    9. repec:fip:fedker:00052 is not listed on IDEAS
    10. repec:eee:ecolet:v:165:y:2018:i:c:p:65-69 is not listed on IDEAS
    11. Atalay, Enghin & Drautzburg, Thorsten & Wang, Zhenting, 2018. "Accounting for the sources of macroeconomic tail risks," Economics Letters, Elsevier, vol. 165(C), pages 65-69.

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