Interaction-driven macroeconomic fluctuations

Only a portion of aggregate fluctuations can be attributed to identifiable aggregate shocks. In this paper, I explore the hypothesis that interactions among idiosyncratic shocks generate sizable aggregate fluctuations. I begin by reviewing how idiosyncratic shocks tend to cancel one another out under the central limit theorem. This diversification effect weakens in certain environments, particularly when micro-level actions are discrete and perfectly complementary. Such environments arise in three macroeconomic settings: (1) aggregate investment when firms’ production technologies are duplicable and indivisible; (2) inflation when money is neutral in the long run but prices are sticky in the short run; and (3) asset prices under asymmetric information, where traders engage in Keynes’s beauty contest by inferring one another’s private information. I present three models developed in my previous research. The resulting fluctuations arise in the absence of exogenous aggregate shocks yet exhibit a characteristic fat-tailed distribution of synchronized actions.