Sectoral Shocks and Aggregate Fluctuations

Abstract

This paper presents a multisector dynamic general equilibrium model of business cycles with a distinctive feature: aggregate fluctuations are driven by independent sectoral shocks. The model hypothesizes that trade among sectors provides a strong synchronization mechanism for these shocks due to the limited, but locally intense, interaction that is characteristic of such input trade flows. Limited interaction, characterized by a sparse intermediate input-use matrix, reduces substitution possibilities among intermediate inputs which strengthens co-movement in sectoral value-added and leads to a postponement of the law of large numbers in the variance of aggregate value-added. The chief virtue of this model is that reliance on implausible aggregate shocks is not necessary to capture the qualitative features of macroeconomic fluctuations. Building on Horvath (1997), which establishes the theoretical foundation for the relevance of limited interaction in the context of a stylized multisector model, this paper specifies a more general multisector model calibrated to the U.S. 2-digit Standard Industrial Code economy. Simulations prove the model is able to match empirical reality as closely as standard one-sector business cycle models without relying on aggregate shocks.

JEL Classification: E1, E32, C67