DP5898 Aggregate Shocks or Aggregate Information? Costly Information and Business Cycle Comovement

Author(s): Laura Veldkamp, Justin Wolfers
Publication Date: October 2006
Keyword(s): business cycles, comovement puzzle, costly information, information markets
JEL(s): D82, E32
Programme Areas: International Macroeconomics, Public Economics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5898

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.