Sectoral shocks and aggregate fluctuations

This paper presents a multisector dynamic general equilibrium model of busi ness cycles with a distinctive feature: aggregate fluctuations are driven b y independent sectoral shocks. The model hypothesizes that trade among sect ors provides a strong synchronization mechanism for these shocks due to the limited, but locally intense, interaction that is characteristic of such i nput trade flows. Limited interaction, characterized by a sparse intermedia te input-use matrix, reduces substitution possibilities among intermediate inputs which strengthens comovement in sectoral value-added and leads to a postponement of the law of large numbers in the variance of aggregate value -added. The chief virtue of this model is that reliance on implausible aggr egate shocks is not necessary to capture the qualitative features of macroe conomic fluctuations. Building on Horvath, 1998, Review of Economic Dynamic s 1, 781-808, which establishes the theoretical foundation for the relevanc e of limited interaction in the context of a stylized multisector model, th is paper specifies a more general multisector model calibrated to the US 2- digit Standard Industrial Code economy. Simulations prove the model :is abl e to match empirical reality as closely as standard one-sector business cyc le models without relying on aggregate shocks. (C) 2000 Elsevier Science B. V. All rights reserved. JEL classification: E1; E32; C67.