Working Paper: CEPR ID: DP5898
Authors: Laura Veldkamp; Justin Wolfers
Abstract: When similar patterns of expansion and contraction are observed across sectors, we call this a business cycle. Yet explaining the similarity and synchronization of these cycles across industries remains a puzzle. Whereas output growth across industries is highly correlated, identifiable shocks, like shocks to productivity, are far less correlated. While previous work has examined complementarities in production, we propose that sectors make similar input decisions because of complementarities in information acquisition. Because information about driving forces has a high fixed cost of production and a low marginal cost of replication, it can be more efficient for firms to share the cost of discovering common shocks than to invest in uncovering detailed sectoral information. Firms basing their decisions on this common information make highly correlated production choices. This mechanism amplifies the effects of common shocks, relative to sectoral shocks.
Keywords: business cycles; comovement; puzzle; costly information; information markets
JEL Codes: D82; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Information acquisition (D83) | Labor input decisions (J29) |
| Labor input decisions (J29) | Output comovement (C10) |
| Aggregate information (C43) | Labor input decisions (J29) |
| Aggregate information (C43) | Excess comovement in output (E19) |
| Cost sharing in information acquisition (D16) | Correlated production choices across sectors (E23) |
| Degree of information shared (D89) | Output correlation among industries (L69) |
| Output correlation (C10) | Total factor productivity (TFP) correlation (O49) |