Aggregate Fluctuations from Firm Comovement

Abstract

This paper shows that correlated idiosyncratic fluctuations among firms within industries are an important source of macroeconomic volatility. Standard methods, such as cross-sectional demeaning, obscure this channel by mechanically driving average pairwise correlations toward zero asymptotically. We develop a non-parametric bounds approach that quantifies the contribution of such clustered comovement directly from firm-level data. Applied to U.S. firms, we find that within-industry comovement explains 10–15% of GDP volatility in normal times, 15–30% in downturns, and up to 40% following the Great Recession, helping account for the Great Moderation. These findings highlight the importance of cross-firm interdependencies in business cycle fluctuations.