Aggregation, Persistence and Volatility in a Macro Model

Review of Economic Studies, Vol. 69, No. 4, pp. 749-779, October 2002

47 Pages Posted: 15 Jan 2012

See all articles by Karim M. Abadir

Karim M. Abadir

Imperial College Business School

Gabriel Talmain

University of York - Department of Economics and Related Studies

Date Written: 2002

Abstract

We introduce firm heterogeneity into the standard monopolistically-competitive Real Business Cycle (RBC) model. The fundamental equilibrium path is derived and the time series properties of aggregate GDP are studied analytically. Although firms' productivities are subject to temporary shocks, the aggregate process displays a surprising novel form of nonlinearity and long memory which had not been built into the model at the outset. This aggregate GDP turns out to have very different properties from log-linear time series models such as Auto-Regressive (AR) models and their extensions. It displays very strong persistence, which ends abruptly with a sudden change of tendency, giving its Auto-Correlation Function (ACF) an S-shape. Although persistent, it is mean-reverting, unlike the everlasting memory of unit-root processes. Its volatility is of a greater order of magnitude than that of any of its components, so small micro shocks can generate large macro fluctuations. It is also characterized by long, asymmetric cycles of random lengths. Increased monopoly power tends to reduce the amplitude and increase the persistence of business cycles. Strikingly, we find that the empirical ACFs constructed from GDP data for the UK and the US display this characteristic S-shape.

Suggested Citation

Abadir, Karim M. and Talmain, Gabriel, Aggregation, Persistence and Volatility in a Macro Model (2002). Review of Economic Studies, Vol. 69, No. 4, pp. 749-779, October 2002. Available at SSRN: https://ssrn.com/abstract=1985288

Karim M. Abadir (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www3.imperial.ac.uk/portal/page?_pageid=61,629646&_dad=portallive&_schema=PORTALLIVE

Gabriel Talmain

University of York - Department of Economics and Related Studies ( email )

Heslington
York, YO1 5DD
United Kingdom

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