Microeconomic Origins of Macroeconomic Tail Risks
Coauthor(s): Daron Acemoglu, Asuman Ozdaglar.
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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.
Acemoglu, Daron, Asuman Ozdaglar, and Alireza Tahbaz-Salehi. "Microeconomic Origins of Macroeconomic Tail Risks." Columbia Business School, December 2014.