DP10587 Large Firm Dynamics and the Business Cycle

Author(s): Vasco M Carvalho, Basile Grassi
Publication Date: May 2015
Keyword(s): aggregate fluctuations, firm size distribution, large firm dynamics, random growth
JEL(s): E32, L11
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10587

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.