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Optimal monetary policy and firm entry

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  • Lewis, Vivien

Abstract

This paper characterises optimal monetary policy in an economy with endogenous firm entry, a cash-in-advance constraint and preset wages. Firms must make pro fits to cover entry costs; thus the markup on goods prices is efficient. However, because leisure is not priced at a markup, the consumption-leisure tradeoff is distorted. Consequently, the real wage, hours and production are suboptimally low. Due to the labour requirement in entry, insufficient labour supply also implies that entry is too low. The paper shows that in the absence of fiscal instruments such as labour income subsidies, the optimal monetary policy under sticky wages achieves higher welfare than under flexible wages. The policy maker uses the money supply instrument to raise the real wage - the cost of leisure - above its flexible-wage level, in response to expansionary shocks to productivity and entry costs. This raises labour supply, expanding production and rm entry. --

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Bibliographic Info

Paper provided by Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt in its series IMFS Working Paper Series with number 50.

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Date of creation: 2012
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Handle: RePEc:zbw:imfswp:50

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Keywords: entry; optimal monetary policy; sticky wages;

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  1. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, Econometric Society, vol. 54(3), pages 607-22, May.
  2. Lewis, Vivien, 2009. "Business Cycle Evidence On Firm Entry," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 13(05), pages 605-624, November.
  3. Isabel Horta Correia & Juan Pablo Nicolini & Pedro Teles, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," Working Papers, Banco de Portugal, Economics and Research Department w200303, Banco de Portugal, Economics and Research Department.
  4. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2001. "Gaps and Triangles," Working Papers, Banco de Portugal, Economics and Research Department w200102, Banco de Portugal, Economics and Research Department.
  5. Florin O. Bilbiie & Ippei Fujiwara & Fabio Ghironi, 2011. "Optimal Monetary Policy with Endogenous Entry and Product Variety," NBER Working Papers 17489, National Bureau of Economic Research, Inc.
  6. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 640, Board of Governors of the Federal Reserve System (U.S.).
  7. V. Lewis, 2010. "Product Diversity, Strategic Interactions and Optimal Taxation," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium, Ghent University, Faculty of Economics and Business Administration 10/661, Ghent University, Faculty of Economics and Business Administration.
  8. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, American Economic Association, vol. 67(3), pages 297-308, June.
  9. Christian Broda & David E. Weinstein, 2010. "Product Creation and Destruction: Evidence and Price Implications," American Economic Review, American Economic Association, American Economic Association, vol. 100(3), pages 691-723, June.
  10. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2008. "Monetary Policy and Business Cycles with Endogenous Entry and Product Variety," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 299-353 National Bureau of Economic Research, Inc.
  11. Kim, Jinill, 2004. "What determines aggregate returns to scale?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(8), pages 1577-1594, June.
  12. Riccardo DiCecio & Levon Barseghyan, 2010. "Entry Costs, Industry Structure, and Cross-Country Income and TFP Differences," 2010 Meeting Papers, Society for Economic Dynamics 964, Society for Economic Dynamics.
  13. Aleksander Berentsen & Christopher J. Waller, 2009. "Optimal stabilization policy with endogenous firm entry," Working Papers, Federal Reserve Bank of St. Louis 2009-032, Federal Reserve Bank of St. Louis.
  14. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(4), pages 704-23, August.
  15. Bergin, Paul R. & Corsetti, Giancarlo, 2008. "The extensive margin and monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(7), pages 1222-1237, October.
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Cited by:
  1. Sanjay K. Chugh & Fabio Ghironi, 2012. "Optimal Fiscal Policy with Endogenous Product Variety," Boston College Working Papers in Economics, Boston College Department of Economics 845, Boston College Department of Economics.
  2. Masashige Hamano & Pierre M. Picard, 2013. "Extensive and intensive margins and the choice of exchange rate regimes," CREA Discussion Paper Series 13-18, Center for Research in Economic Analysis, University of Luxembourg.
  3. Florin O. Bilbiie & Ippei Fujiwara & Fabio Ghironi, 2011. "Optimal Monetary Policy with Endogenous Entry and Product Variety," NBER Working Papers 17489, National Bureau of Economic Research, Inc.
  4. Matteo Cacciatore, 2013. "Trade, Unemployment, and Monetary Policy," 2013 Meeting Papers, Society for Economic Dynamics 724, Society for Economic Dynamics.
  5. Giuseppe Fiori & Fabio Ghironi & Matteo Cacciatore, 2012. "Market Deregulation and Optimal Monetary Policy in a Monetary Union," 2012 Meeting Papers, Society for Economic Dynamics 678, Society for Economic Dynamics.

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