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American Economic Review: Vol. 103 No. 5 (August 2013)

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The Great Diversification and Its Undoing

Article Citation

Carvalho, Vasco, and Xavier Gabaix. 2013. "The Great Diversification and Its Undoing." American Economic Review, 103(5): 1697-1727.

DOI: 10.1257/aer.103.5.1697

Abstract

We investigate the hypothesis that macroeconomic fluctuations are primitively the results of many microeconomic shocks. We define fundamental volatility as the volatility that would arise from an economy made entirely of idiosyncratic sectoral or firm-level shocks. Fundamental volatility accounts for the swings in macroeconomic volatility in the major world economies in the past half-century. It accounts for the "great moderation" and its undoing. The initial great moderation is due to a decreasing share of manufacturing between 1975 and 1985. The recent rise of macroeconomic volatility is chiefly due to the growth of the financial sector.

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Authors

Carvalho, Vasco (CREI, U Pompeu Fabra and Barcelona GSE)
Gabaix, Xavier (NYU)

JEL Classifications

E23: Macroeconomics: Production
E32: Business Fluctuations; Cycles
E44: Financial Markets and the Macroeconomy


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