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Firm Dynamics, Inflation, and the Transmission of Monetary Policy

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Abstract

I study how fluctuations in business formation and destruction affect inflation and the transmission of monetary policy. To do this analysis, I extend a New Keynesian model to include endogenous business formation and destruction and heterogeneous producers. A decline in the number of producers puts upward pressure on inflation, and I find that this mechanism can explain about half of the missing deflation following the Great Recession. I then study the transmission of monetary policy in this framework. I show that endogenous fluctuations in entry generate an intertemporal trade-off in monetary policy; a contractionary shock leads employment and inflation to decline on impact, but inflation later overshoots, as the shock also causes a decline in entry and an increase in exit.

Suggested Citation

  • William L. Gamber, 2026. "Firm Dynamics, Inflation, and the Transmission of Monetary Policy," Finance and Economics Discussion Series 2026-003, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:102373
    DOI: 10.17016/FEDS.2026.003
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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