Are firm-level idiosyncratic shocks important for U.S. aggregate volatility?

This paper assesses the quantitative impact of firm-level idiosyncratic shocks on aggregate volatility in the U.S. economy and provides a microfoundation for the negative relationship between firm-level volatility and size. I argue that the role of firm-specific shocks through the granular channel plays a fairly limited role in the U.S. economy. Using a novel, comprehensive data set compiled from several sources of the U.S. Census Bureau, I find that the granular com-ponent accounts at most for 15.5% of the variation in aggregate sales growth which is about half found by previous studies. To bridge the gap between previous findings and mine, I show that my quantitative results require deviations from Gibrat’s law in which firm-level volatility and size are negatively related. I find that firm-level volatility declines at a substantially higher rate in size than previously found. Hence, the largest firms in the economy cannot be driving a sub-stantial fraction of macroeconomic volatility. I show that the explanatory power of granularity gets cut by at least half whenever the size-variance relationship, as estimated in the micro-level data, is taken into account. To uncover the economic mechanism behind this phenomenon, I construct an analytically tractable framework featuring random growth and a Kimball aggrega-tor. Under this setup, larger firms respond less to productivity shocks as the elasticity of demand is decreasing in size. Additionally, the model predicts a positive (negative) relationship between firm-level mark-ups (growth) and size. I confirm the predictions of the model by estimating size-varying price elasticities on unique product-level data from the Census of Manufactures (CM) and structurally estimating mark-ups using plant-level information from the Annual Survey of Manufactures (ASM).