Paper #1481

Title:

Large firm dynamics and the business cycle

Authors:

Vasco Carvalho and Basile Grassi

Date:

April 2015

Abstract:

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 for aggregate output and productivity dynamics display: (i) persistence, (ii) volatility and (iii) 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.

Keywords:

Large Firm Dynamics; Firm Size Distribution; Random Growth; Aggregate Fluctuations.

Area of Research:

Macroeconomics and International Economics

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