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Firm Entry, Inflation and the Monetary Transmission Mechanism

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  • Céline Poilly

    (Université catholique de Louvain)

  • Vivien Lewis

    (Ghent University)

Abstract

This paper estimates a business cycle model with endogenous firm entry by matching impulse responses to a monetary policy shock in US data. Our VAR includes net business formation, profits and markups. We evaluate two channels through which entry may influence the monetary transmission process. Through the competition effect, the arrival of new entrants makes the demand for existing goods more elastic, and thus lowers desired markups and prices. Through the variety effect, increased firm and product entry raises consumption utility and thereby lowers the cost of living. This implies higher markups and, through the New Keynesian Phillips Curve, lower inflation. While the proposed model does a good job at matching the observed dynamics, it generates insufficient volatility of markups and profits. Estimates of standard parameters are largely unaffected by the introduction of firm entry. Our results lend support to the variety effect; however, we find no evidence for the competition effect.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 113.

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Date of creation: 2011
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Handle: RePEc:red:sed011:113

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Cited by:
  1. Henning Weber, 2011. "Optimal inflation and firms' productivity dynamics," Kiel Working Papers 1685, Kiel Institute for the World Economy.
  2. Totzek, Alexander & Winkler, Roland C., 2010. "Fiscal stimulus in model with endogenous firm entry," MPRA Paper 26829, University Library of Munich, Germany, revised Nov 2010.
  3. Lilia Cavallari, 2012. "Modelling Entry Costs: Does It Matter For Business Cycle Transmission?," Working Papers, CREI Università degli Studi Roma Tre 0712, CREI Università degli Studi Roma Tre, revised 2012.

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