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Concentrated Risk: Misallocation and Granular Business Cycles

Author

Listed:
  • Tomer Ifergane

    (Ben-Gurion University of the Negev
    London School of Economics
    Centre For Macroeconomics)

Abstract

This paper uncovers a novel interaction between production efficiency and economic stability. Using a tractable heterogeneous firms model, I prove the existence of an efficiency-stability trade-off in granular economies. Specifically, reducing misallocation increases business cycle volatility. This trade-off originates because firms choose their optimal size without internalizing their effect on aggregate consumption risk. Utilizing approximations and results on order statistics, I propose a tractable method to quantify this effect and show that commonly studied misallocation counterfactuals involve a sizeable increase in business cycle volatility. I discuss how different assumptions on the nature of misallocation and factor mobility influence this result.

Suggested Citation

  • Tomer Ifergane, 2024. "Concentrated Risk: Misallocation and Granular Business Cycles," Discussion Papers 2438, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2438
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    File URL: https://www.lse.ac.uk/CFM/assets/pdf/CFM-Discussion-Papers-2024/CFMDP2024-38-Paper.pdf
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    More about this item

    Keywords

    Business cycles; misallocation; granularity; stabilization policies; size-dependent policies;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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