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Firm Entry, Inflation and the Monetary Transmission Mechanism

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  • V. LEWIS

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  • 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.

Suggested Citation

  • V. Lewis & C. Poilly, 2011. "Firm Entry, Inflation and the Monetary Transmission Mechanism," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 11/705, Ghent University, Faculty of Economics and Business Administration.
  • Handle: RePEc:rug:rugwps:11/705
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    Cited by:

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    2. Totzek, Alexander & Winkler, Roland C., 2010. "Fiscal stimulus in model with endogenous firm entry," MPRA Paper 26829, University Library of Munich, Germany, revised Nov 2010.

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    More about this item

    Keywords

    entry; in?ation; monetary transmission; monetary policy; extensive margin;
    All these keywords.

    JEL classification:

    • 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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