Cyclicality and sectoral linkages: Aggregate fluctuations from independent sectoral shocks

Abstract

The traditional argument against the relevance of sector-specific shocks for the aggregate phenomenon of business cycles invokes the law of large numbers: positive shocks in some sectors are offset by negative shocks in other sectors. This paper hypothesizes that cancellation of sector-specific shocks via the law of large numbers is affected by interactions among producing sectors. The analysis is performed within the context of a multisector model similar in spirit to that of Long and Plosser [J. Polit. Econ.91(1983), 39-69]. It is shown that the rate at which the law of large numbers applies is controlled by the rate of increase in the number offullrows in the input-use matrix rather than by the rate of increase in the total number of sectors. Investigations of actual input-use matrices from the U.S. economy reveal that the number of full rows increases much slower than the total number of rows upon disaggregation, and when these input-use matrices are used to parameterize the model, aggregate volatility from sectoral shocks declines at less than half the rate implied by the law of large numbers. This finding leaves open the possibility that a sizeable portion of aggregate volatility is caused by "smaller" shocks to individual sectors. Simple statistics calculated from the model indicate that as much as 80% the volatility in U.S. gross domestic product growth rates could be the result of independent shocks to two-digit Standard Industrial Code sectors.Journal of Economic LiteratureClassification Numbers: E1, E32, C67. © 1998 Academic Press.