Entry costs and the dynamics of business formation

This paper studies the implications of entry costs for business formation in a dynamic stochastic general equilibrium model with endogenous entry and exit. The paper first documents some facts about business formation in the US. Exit is more volatile than entry, both are more volatile than output and co-move over the cycle. Firms are less volatile than output and pro-cyclical. Then, it shows that a model with entry and exit can replicate these facts fairly well. In addition it captures important features of the US business cycle, outperforming models with a fixed exit rate and a fixed number of firms. The performance of the model is sensitive to changes in the composition of entry costs.