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

41 Pages Posted: 28 Dec 2006

See all articles by Laura Veldkamp

Laura Veldkamp

Columbia University - Columbia Business School; National Bureau of Economic Research (NBER)

Justin Wolfers

University of Michigan at Ann Arbor - Department of Economics; University of Michigan at Ann Arbor - Gerald R. Ford School of Public Policy; The University of Sydney - Discipline of Economics; Brookings Institution - Economic Studies Program; Peterson Institute for International Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Kiel Institute for the World Economy

Multiple version iconThere are 4 versions of this paper

Date Written: October 2006

Abstract

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.

Keywords: Business cycles, comovement puzzle, costly information, information markets

JEL Classification: D82, E32

Suggested Citation

Veldkamp, Laura and Wolfers, Justin, Aggregate Shocks or Aggregate Information? Costly Information and Business Cycle Comovement (October 2006). CEPR Discussion Paper No. 5898, Available at SSRN: https://ssrn.com/abstract=954014

Laura Veldkamp

Columbia University - Columbia Business School ( email )

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Justin Wolfers (Contact Author)

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