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Speaker:
Alessandro Ferrari (University of Zurich)

Firm Heterogeneity, Market Power and Macroeconomic Fragility

We investigate the connection between long run changes in market structure and the deviation of the US economy from its long run trend after the 2008-9 crisis. We provide a theory in which temporary negative aggregate shocks trigger changes in the competitive environment that can lead to deep quasi-permanent recessions. In our RBC model with oligopolistic competition and free entry, the magnitude of the changes in the market structure increases with the degree of firm heterogeneity in the economy.  We use a quantitative version of our model to study the response of the US economy to the Great Recession of 2008-09. The model can rationalize the persistent deviation of output and most macroeconomic aggregates from trend. In counterfactual exercises, we find that if the aggregate shocks of 2008-9 had hit an economy with lower firm heterogeneity we would not have observed such a deep and persistent recession. Quantitatively, an economy with the 1985 level of firm heterogeneity is 63% less likely to experience a recession like 2008-9. We show that policies targeted at reducing the responsiveness of the competitive environment to aggregate shocks can significantly increase welfare by avoiding quasi-permanent recessions.

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