Networks and Business Cycles

82 Pages Posted: 2 Mar 2021

See all articles by Wu Zhu

Wu Zhu

University of Pennsylvania

Yucheng Yang

Princeton University

Date Written: October 26, 2020

Abstract

The speed at which the US economy has recovered from recessions ranges from months to years. We propose a model incorporating the innovation network, the production network, and cross-sectional shocks and show that their interactions jointly explain large variations in the recovery speed across recessions in the US.

In the model, besides the production linkages, firms learn insights on production from each other through the innovation network. We show when the innovation network takes a low-rank structure, there exists one key direction: the impact a shock becomes persistent only if the shock is parallel to this key direction; in contrast, the impact declines quickly if the shock follows other directions.

Empirically, we estimate the model in a state-space form and document a set of new stylized facts of the US economy. First, the innovation network among sectors takes a low-rank structure. Second, the innovation network has non-negligible overlap with the production network. Third, recessions with slow recovery are those witnessing sizable negative shock to sectors in the center of the innovation network. Such network structures and the time-varying sectoral distribution of the shocks can well explain the large variation in the recovery speed across recessions in the US. Finally, to emphasize the prevalence of the channel, we explore the application of the theory in asset pricing.

Keywords: Business Cycles, Innovation Networks, Production Networks, Sectoral Shock, Persistence, Amplification

JEL Classification: D85, F36, G32, G33, G38

Suggested Citation

Zhu, Wu and Yang, Yucheng, Networks and Business Cycles (October 26, 2020). Available at SSRN: https://ssrn.com/abstract=3718826 or http://dx.doi.org/10.2139/ssrn.3718826

Wu Zhu (Contact Author)

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

Yucheng Yang

Princeton University ( email )

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