Les Cahiers de Recherche - HEC Paris
Instabilities in Large Economies: Aggregate Volatility Without Idiosyncratic Shocks
() and Augustin Landier
Abstract: The authors study a dynamical model of interconnected
firms which allows for certain market imperfections and frictions,
restricted here to be myopic price forecasts and slow adjustment of
production. Whereas the standard rational equilibrium is still formally a
stationary solution of the dynamics, the authors show that this equilibrium
becomes linearly unstable in a whole region of parameter space. When agents
attempt to reach the optimal production target too quickly, coordination
breaks down and the dynamics becomes chaotic.
In the unstable,
"turbulent", phase the aggregate volatility of the total output remains
substantial even when the amplitude of idiosyncratic shocks goes to zero or
when the size of the economy becomes large. In other words, crises become
endogenous. This suggests an interesting resolution of the "small shocks,
large business cycles" puzzle.
Keywords: volatility of aggregate output; network theory; rational expectations; general equilibrium; (follow links to similar papers)
22 pages, June 20, 2014
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