Microeconomic Origins of Macroeconomic Tail Risks

48 Pages Posted: 17 Jan 2015 Last revised: 25 Aug 2015

See all articles by Daron Acemoglu

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

Northwestern University - Kellogg School of Management

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Date Written: August 13, 2015

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: Business cycles, Domar weights, large economic downturns, network heterogeneity, input-output linkages, tail risks

JEL Classification: C67, E32

Suggested Citation

Acemoglu, Daron and Ozdaglar, Asuman E. and Tahbaz-Salehi, Alireza, Microeconomic Origins of Macroeconomic Tail Risks (August 13, 2015). MIT Department of Economics Working Paper No. 15-01; Columbia Business School Research Paper No. 15-10. Available at SSRN: https://ssrn.com/abstract=2550551 or http://dx.doi.org/10.2139/ssrn.2550551

Daron Acemoglu (Contact Author)

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National Bureau of Economic Research (NBER)

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Asuman E. Ozdaglar

Massachusetts Institute of Technology (MIT) - Department of Electrical Engineering and Computer Science ( email )

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Alireza Tahbaz-Salehi

Northwestern University - Kellogg School of Management ( email )

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