Working Paper: NBER ID: w16516
Authors: Daron Acemoglu; Asuman Ozdaglar; Alireza Tahbazsalehi
Abstract: We provide a general framework for the study of cascade effects created by interconnections between sectors, firms or financial institutions. Focusing on a multi sector economy linked through a supply network, we show how structural properties of the supply network determine both whether aggregate volatility disappears as the number of sectors increases (i.e., whether the law of large numbers holds) and when it does, the rate at which this happens. Our main results characterize the relationship between first order interconnections (captured by the weighted degree sequence in the graph induced by the input-output relations) and aggregate volatility, and more importantly, the relationship between higher-order interconnections and aggregate volatility. These higher-order interconnections capture the cascade effects, whereby low productivity or the failure of a set of suppliers propagates through the rest of the economy as their downstream sectors/firms also suffer and transmit the negative shock to their downstream sectors/firms. We also link the probabilities of tail events (large negative deviations of aggregate output from its mean) to sector-specific volatility and to the structural properties of the supply network.
Keywords: Cascades; Aggregate Volatility; Supply Networks
JEL Codes: C67; D57; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| supply network structure (D85) | aggregate volatility (E10) |
| number of sectors increases (O41) | concentration of aggregate output around a constant value (E23) |
| starlike network (D85) | aggregate volatility does not diminish (E10) |
| higher-order interconnections (Y80) | exacerbate effects of idiosyncratic shocks (E71) |
| degree distribution follows power law (C46) | aggregate volatility decreases at a slower rate (E10) |