Discussion Paper Details

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Title: Aggregate Shocks or Aggregate Information? Costly Information and Business Cycle Comovement

Author(s): Laura Veldkamp and Justin Wolfers

Publication Date: October 2006

Keyword(s): business cycles, comovement puzzle, costly information and information markets

Programme Area(s): Financial Economics, International Macroeconomics and Public Economics

Abstract: When similar patterns of expansion and contraction are observed across sectors, we call this a business cycle. Yet explaining the similarity and synchronization of these cycles across industries remains a puzzle. Whereas output growth across industries is highly correlated, identifiable shocks, like shocks to productivity, are far less correlated. While previous work has examined complementarities in production, we propose that sectors make similar input decisions because of complementarities in information acquisition. Because information about driving forces has a high fixed cost of production and a low marginal cost of replication, it can be more efficient for firms to share the cost of discovering common shocks than to invest in uncovering detailed sectoral information. Firms basing their decisions on this common information make highly correlated production choices. This mechanism amplifies the effects of common shocks, relative to sectoral shocks.

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Bibliographic Reference

Veldkamp, L and Wolfers, J. 2006. 'Aggregate Shocks or Aggregate Information? Costly Information and Business Cycle Comovement'. London, Centre for Economic Policy Research.