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Firm Entry, Inflation and the Monetary Transmission Mechanism

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  • V. LEWIS

    ()

  • C. POILLY

Abstract

This paper estimates a business cycle model with endogenous ?rm entry by matching impulse responses to a monetary policy shock in US data. Our VAR includes net business formation, pro?ts and markups. We evaluate two channels through which entry may in?uence 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 ?rm 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 in?ation. While the proposed model does a good job at matching the observed dynamics, it generates insufficient volatility of markups and pro?ts. Estimates of standard parameters are largely unaffected by the introduction of ?rm entry. Our results lend support to the variety e¤ect; however, we ?nd no evidence for the competition effect.

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Bibliographic Info

Paper provided by Ghent University, Faculty of Economics and Business Administration in its series Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium with number 11/705.

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Length: 35 pages
Date of creation: Jan 2011
Date of revision:
Handle: RePEc:rug:rugwps:11/705

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Keywords: entry; in?ation; monetary transmission; monetary policy; extensive margin;

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  1. Céline Poilly, 2007. "Does Money Matter for the Identification of Monetary Policy Shocks: A DSGE Perspective," THEMA Working Papers 2007-23, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
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  11. Lewis, Vivien, 2009. "Business Cycle Evidence On Firm Entry," Macroeconomic Dynamics, Cambridge University Press, vol. 13(05), pages 605-624, November.
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  18. Benassy, Jean-Pascal, 1991. "Monopolistic competition," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 37, pages 1997-2045 Elsevier.
  19. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2007. "Monetary Policy and Business Cycles with Endogenous Entry and Product Variety," NBER Working Papers 13199, National Bureau of Economic Research, Inc.
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  23. Christopoulou, Rebekka & Vermeulen, Philip, 2008. "Markups in the euro area and the US over the period 1981-2004: a comparison of 50 sectors," Working Paper Series 0856, European Central Bank.
  24. Martina Cecioni, 2010. "Firm entry, competitive pressures and the US inflation dynamics," Temi di discussione (Economic working papers) 773, Bank of Italy, Economic Research and International Relations Area.
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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. Lilia Cavallari, 2012. "Modelling Entry Costs: Does It Matter For Business Cycle Transmission?," Working Papers 0712, CREI Università degli Studi Roma Tre, revised 2012.
  3. Totzek, Alexander & Winkler, Roland C., 2010. "Fiscal stimulus in a model with endogenous firm entry," Economics Working Papers 2010,05, Christian-Albrechts-University of Kiel, Department of Economics.

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