An Explanation for the Joint Evolution of Firm and Aggregate Volatility

Abstract

The US economy has become more stable. At the same time, US firms have become more volatile. I present the evidence and I propose a common explanation, based on the idea that goods markets have become more competitive. Competition between firms magnifies the effects of idiosyncratic productivity shocks: This can explain the rise in firm volatility. On the other hand, for given nominal adjustment costs, competitive pressures will induce firms to increase the frequency of their price adjustments. As a result, the economy will be more resilient to aggregate demand shocks. My calibration suggests that competitive pressures may have reduced the impact of demand shocks by 40%.