The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten's Theorem

72 Pages Posted: 2 Feb 2017 Last revised: 16 Jan 2018

See all articles by David Baqaee

David Baqaee

London School of Economics and Political Science, Department of International Development, Students

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: January 15, 2018

Abstract

We provide a nonlinear characterization of the macroeconomic impact of microeconomic TFP shocks in terms of reduced-form non-parametric elasticities for efficient economies. We also provide the mapping from structural parameters to these reduced-form elasticities, under general equilibrium. In this sense, the paper extends the foundational theorem of Hulten (1978) beyond first-order terms to capture nonlinearities. Key features ignored by first-order approximations that play a crucial role are: structural elasticities of substitution, network linkages, structural returns to scale, and the degree to which factors can be reallocated. Higher-order terms are large and economically interesting: they magnify negative shocks and attenuate positive shocks, resulting in an output distribution that is asymmetric (negative skewness), fat-tailed (excess kurtosis), and has a lower mean. They explain how small microeconomic shocks to critical sectors can have a large macroeconomic impact. To give a sense of magnitudes: in our benchmark calibration, output losses due to business cycle fluctuations are 0.6% of GDP, an order of magnitude larger than the cost of business cycles calculated by Lucas (1987), and are entirely due to a reduction in the mean of GDP because of nonlinearities in production; and accounting for second order terms increases the estimated impact of the price shock to the critical sector of oil in the 1970s from 0.2% to 0.6% of world GDP.

Keywords: Granular, Networks, Sectoral Shocks, Hulten, Input-output

JEL Classification: E10, E30, D50, E20

Suggested Citation

Baqaee, David and Farhi, Emmanuel, The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten's Theorem (January 15, 2018). Available at SSRN: https://ssrn.com/abstract=2909855 or http://dx.doi.org/10.2139/ssrn.2909855

David Baqaee (Contact Author)

London School of Economics and Political Science, Department of International Development, Students ( email )

London
United Kingdom

HOME PAGE: http://sites.google.com/site/davidbaqaee/

Emmanuel Farhi

Harvard University - Department of Economics ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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