Instabilities in Large Economies: Aggregate Volatility Without Idiosyncratic Shocks

22 Pages Posted: 21 Jun 2014 Last revised: 17 Sep 2014

See all articles by Julius Bonart

Julius Bonart

Capital Fund Management

Jean-Philippe Bouchaud

Capital Fund Management

Augustin Landier

HEC

David Thesmar

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA)

Date Written: June 20, 2014

Abstract

We study a dynamical model of interconnected firms which allows for certain market imperfections and frictions, restricted here to be myopic price forecasts and slow adjustment of production. Whereas the standard rational equilibrium is still formally a stationary solution of the dynamics, we show that this equilibrium becomes linearly unstable in a whole region of parameter space. When agents attempt to reach the optimal production target too quickly, coordination breaks down and the dynamics becomes chaotic.

In the unstable, "turbulent", phase the aggregate volatility of the total output remains substantial even when the amplitude of idiosyncratic shocks goes to zero or when the size of the economy becomes large. In other words, crises become endogenous. This suggests an interesting resolution of the "small shocks, large business cycles" puzzle.

Keywords: volatility of aggregate output, network theory, rational expectations, general equilibrium

Suggested Citation

Bonart, Julius and Bouchaud, Jean-Philippe and Landier, Augustin and Thesmar, David, Instabilities in Large Economies: Aggregate Volatility Without Idiosyncratic Shocks (June 20, 2014). HEC Paris Research Paper No. FIN-2014-1052. Available at SSRN: https://ssrn.com/abstract=2456936 or http://dx.doi.org/10.2139/ssrn.2456936

Julius Bonart (Contact Author)

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

Jean-Philippe Bouchaud

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France
+33 1 49 49 59 20 (Phone)

Augustin Landier

HEC ( email )

France
+33630006051 (Phone)

HOME PAGE: http://https://sites.google.com/site/augustinlandier/

David Thesmar

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States
16172259767 (Phone)

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