The Great Diversification and its Undoing

By Vasco M. Carvalho, Xavier Gabaix. 2013

278 citations recorded by the source corpus.

We investigate the hypothesis that macroeconomic fluctuations are primitively the results of many microeconomic shocks, and show that it has significant explanatory power for the evolution of macroeconomic volatility. We define “fundamental” volatility as the volatility that would arise from an economy made entirely of idiosyncratic microeconomic shocks, occurring primitively at the level of sectors or firms. In its empirical construction, motivated by a simple model, the sales share of different sectors vary over time (in a way we directly measure), while the volatility of those sectors remains constant. We find that fundamental volatility accounts for the swings in macroeconomic volatility in the US and the other major world economies in the past half century. It accounts for the “great moderation” and its undoing. Controlling for our measure of fundamental volatility, there is no break in output volatility. The initial great moderation is due to a decreasing share of manufacturing between 1975 and 1985. The recent rise of macroeconomic volatility is due to the increase of the size of the financial sector. We provide a model to think quantitatively about the large comovement generated by idiosyncratic shocks. As the origin of aggregate shocks can be traced to identifiable microeconomic shocks, we may better understand the origins of aggregate fluctuations.

View Paper: https://www.semanticscholar.org/paper/2a46eed98e9d32bb21ce6315b05f87ef3b6a32b0

Citations in the corpus

• Productivity and Misallocation in General Equilibrium* (2017, unknown): “It provides a unified framework for analyzing the effects of distortions and misallocation in general equilibrium economies, the study 1Although we refer to this idea as Domar aggregation, after Evesy Domar, the basic idea of using sales shares to weight changes in a price or quantity can be traced ”
• The Multiprod project: A comprehensive overview (2017, unknown): “Similarly to Carvalho and Gabaix (2013), one can decompose the within-industry component of the wage variance into the labour-weighted wage variance of industries, as shown in Equation (40).”
• Firm Volatility in Granular Networks (2013, unknown): “, Long and Plosser (1987), Acemoglu, Carvalho, Ozdaglar, and Tahbaz-Salehi (2012) and Carvalho and Gabaix (2013)) typically considers downstream transmission of shocks from intermediary goods to final goods producers.”
• Evidence on business cycles and CO2 emissions (2014, unknown): “[9] M. V. Carvalho and X Gabaix.”
• Networks in Production: Asset Pricing Implications (2017, unknown): “My model is also closely related to the work of Acemoglu, Carvalho, Ozdaglar, and Tahbaz-Salehi (2012). They show that aggregate fluctuations can be generated from sectoral idiosyncratic shocks when sectors are connected by input-output linkages.”
• Input Specificity and the Propagation of Idiosyncratic Shocks in Production Networks (2016, unknown): “…of papers challenge this intuition: the first is based on the idea that large firms contribute disproportionately to total output (Gabaix 2011; Carvalho and Gabaix 2013); the second stream posits that shocks are transmitted in the economy through industry linkages (Long and Plosser 1987;…”
• Borrowers under water! Rare disasters, regional banks, and recovery lending (2020, unknown): “5Recent business cycle studies emphasize firm-specific shocks to explain aggregate investment and output dynamics (Khan and Thomas, 2008; Carvalho and Gabaix, 2013).”
• Firms, Destinations, and Aggregate Fluctuations (2014, unknown): “Using the same metric, Haltiwanger (1997) and Castro et al. (2011) find that idiosyncratic shocks account for more than 90% of the variation in firm growth rates in the U.”