The elastic origins of tail asymmetry

TL;DR

This paper demonstrates how sectoral elasticity of substitution influences the asymmetry of macroeconomic fluctuations' tails and the economy's robustness, supported by empirical estimates for Japan and comparisons with the US.

Contribution

It introduces a multisector general equilibrium model linking elasticity of substitution to tail asymmetry and robustness, with empirical sectoral elasticity estimates for Japan.

Findings

Japan's production economy is elastic overall.

Contrasts with inelastic US economy explain tail asymmetry differences.

Sectoral elasticities influence expected output growth under productivity shocks.

Abstract

Based on a multisector general equilibrium framework, we show that the sectoral elasticity of substitution plays the key role in the evolution of asymmetric tails of macroeconomic fluctuations and the establishment of robustness against productivity shocks. Non-unitary elasticity of substitution renders a nonlinear Domar aggregation, where normal sectoral productivity shocks translate into non-normal aggregated shocks with variable expected output growth. We empirically estimate 100 sectoral elasticities of substitution, using the time-series linked input-output tables for Japan, and find that the production economy is elastic overall, relative to Cobb-Douglas with unitary elasticity. Along with the previous assessment of an inelastic production economy for the US, the contrasting tail asymmetry of the distribution of aggregated shocks between the US and Japan is explained. Moreover, robustness of an economy is assessed by the expected output growth, the level of which is led by the sectoral elasticities of substitution, under zero mean productivity shocks.