Working Paper: NBER ID: w20865
Authors: Daron Acemoglu; Asuman Ozdaglar; Alireza Tahbazsalehi
Abstract: We document that even though the normal distribution provides a good approximation to GDP fluctuations, it severely underpredicts “macroeconomic tail risks,” that is, the frequency of large economic downturns. Using a multi-sector general equilibrium model, we show that the interplay of idiosyncratic microeconomic shocks and sectoral heterogeneity results in systematic departures in the likelihood of large economic downturns relative to what is implied by the normal distribution. Notably, we also show that such departures can happen while GDP is approximately normally distributed away from the tails, highlighting the qualitatively different behavior of large economic downturns from small or moderate fluctuations. We further demonstrate the special role that input-output linkages play in generating “tail comovements,” whereby large recessions involve not only significant GDP contractions, but also large simultaneous declines across a wide range of sectors.
Keywords: Macroeconomic Tail Risks; Microeconomic Shocks; Sectoral Heterogeneity
JEL Codes: C67; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| microeconomic shocks (E39) | macroeconomic tail risks (E39) |
| microeconomic shocks (normally distributed) (D39) | no macroeconomic tail risks (E66) |
| sectoral dominance (L52) | macroeconomic tail risks (E39) |
| structural changes (L16) | aggregate volatility (decrease) (E10) |
| structural changes (L16) | macroeconomic tail risks (increase) (E39) |
| input-output linkages (D57) | tail comovements (F29) |
| microeconomic shocks + sectoral dominance (F41) | macroeconomic tail risks (E39) |