The Network Origins of Large Economic Downturns

July 16, 2013 Leave a comment

The Network Origins of Large Economic Downturns

Daron Acemoglu Massachusetts Institute of Technology (MIT) – Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Asuman E. Ozdaglar Massachusetts Institute of Technology (MIT) – Department of Electrical Engineering and Computer Science

Alireza Tahbaz-Salehi Columbia Business School – Decision Risk and Operations

June 13, 2013
Columbia Business School Research Paper

Abstract: 
This paper shows that large economic downturns may result from the propagation of microeconomic shocks over the input-output linkages across different firms or sectors within the economy. Building on the framework of Acemoglu et al. (2012), we argue that the economy’s input-output structure can fundamentally reshape the distribution of aggregate output, increasing the likelihood of large downturns from infinitesimal to substantial. More specifically, we show that an economy with non-trivial intersectoral input-output linkages that is subject to thin-tailed productivity shocks may exhibit deep recessions as frequently as economies that are subject to heavy-tailed shocks. Moreover, we show that in the presence of input-output linkages, aggregate volatility is not necessarily a sufficient statistic for the likelihood of large downturns. Rather, depending on the shape of the distribution of the idiosyncratic shocks, different features of the economy’s input-output network may be of first-order importance. Finally, our results establish that the effects of the economy’s input-output structure and the nature of the idiosyncratic firm-level shocks on aggregate output are not separable, in the sense that the likelihood of large economic downturns is determined by the interplay between the two.

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