This month's featured article
Geography, Idiosyncratic Shocks, and Aggregate Fluctuations
Esteban ROSSI-HANSBERG Professor, Princeton University
Economies experience a variety of local shocks: Natural disasters and weather related disruptions, discoveries of natural resources, disruptions of particular trade routes, corporate bankruptcies and other shocks to local firms, and labor strikes are a few examples. Moreover, industry shocks are local since industries are unevenly distributed in space. Many of these local shocks are too small to affect the aggregate economy and to have an impact that goes beyond the very town, firm, or industry that it affects directly. However, other shocks can have widespread effects on states, other sectors, and, importantly, the aggregate economy.
Japan experienced this first-hand with the economic effect of the earthquake and tsunami, as did cities like New Orleans in the case of Hurricane Katrina, or states like Michigan with the troubles of U.S. automakers, or California with inventions in the high-tech industry. Examples of local shocks abound, but do these shocks have sizable aggregate implications? Can we gauge and measure the effect of these shocks on aggregate outcomes? What does the elasticity of aggregate productivity, output, and employment depend on? Understanding the answer to these questions is essential for the design of policies to alleviate and manage the effect of shocks to the economy.
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