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Monetary Policy and Business Cycles with Endogenous Entry and Product Variety

In: NBER Macroeconomics Annual 2007, Volume 22

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  • Florin O. Bilbiie
  • Fabio Ghironi
  • Marc J. Melitz

Abstract

This paper studies the role of endogenous producer entry and product creation for monetary policy analysis and business cycle dynamics in a general equilibrium model with imperfect price adjustment. Optimal monetary policy stabilizes product prices, but lets the consumer price index vary to accommodate changes in the number of available products. The free-entry condition links the price of equity (the value of products) with marginal cost and markups and hence with inflation dynamics. No-arbitrage between bonds and equity links the expected return on shares, and thus the financing of product creation, with the return on bonds, affected by monetary policy via interest rate setting. This new channel of monetary policy transmission through asset prices restores the Taylor Principle in the presence of capital accumulation (in the form of new production lines) and forward-looking interest rate setting, unlike in models with traditional physical capital. We also study the implications of endogenous variety for the New Keynesian Phillips curve and business cycle dynamics more generally, and we document the effects of technology, deregulation, and monetary policy shocks, as well as the second moment properties of our model, by means of numerical examples.
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Suggested Citation

  • 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.
    • Handle: RePEc:nbr:nberch:4090
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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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