Large Firm Dynamics and the Business Cycle

By Vasco Carvalho and Basile Grassi

http://d.repec.org/n?u=RePEc:bge:wpaper:824&r=dge

Do large firm dynamics drive the business cycle? We answer this question by developing a quantitative theory of aggregate fluctuations caused by firm-level disturbances alone. We show that a standard heterogeneous firm dynamics setup already contains in it a theory of the business cycle, without appealing to aggregate shocks. We offer a complete analytical characterization of the law of motion of the aggregate state in this class of models – the firm size distribution – and show that the resulting closed form solutions imply aggregate output and productivity dynamics which are: (i) persistent, (ii) volatile and (iii) exhibit time-varying second moments. We explore the key role of moments of the firm size distribution – and, in particular, the role of large firm dynamics – in shaping aggregate fluctuations, theoretically, quantitatively and in the data.

The message of this paper: the distribution of firms changes over time, it matters and can create fluctuations that are consistent to what we assume for a typical business cycle model. In other words, we could be endogenizing here all the way to the firm-level the aggregate shocks we always rely on.

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