Local Complementarities and Aggregate Fluctuations

Accumulating microeconomic evidence points both to firm level adjustment lumpiness and to the significant influence of idiosyncratic disturbances. Do these matter for aggregate fluctuations, or do their effects largely vanish upon aggregation? This paper explores the implications of local strategic complementarities and firm-level adjustment lumpiness for aggregate fluctuations. It shows that small (industry-level), serially uncorrelated disturbances which are independent across industries can generate large, persistent aggregate fluctuations, even in the absence of aggregate shocks. This general amplification and propagation mechanism is explored in the context of a simple dynamic general equilibrium model. In this model, economy-wide fluctuations are driven entirely by independent industry-specific disturbances which are propagated via output market interactions. Results are encouraging: many key qualitative features of macroeconomic fluctuations are captured even by this simple model, indicating that this class of models, which builds upon microeconomic features that characterize the economy, surely merits further investigation.