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Firm Entry, Inflation and the Monetary Transmission Mechanism

  • V. LEWIS



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.

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Paper provided by Ghent University, Faculty of Economics and Business Administration in its series Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium with number 11/705.

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Length: 35 pages
Date of creation: Jan 2011
Date of revision:
Handle: RePEc:rug:rugwps:11/705
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  20. Christiano, Lawrence J. & Trabandt, Mathias & Walentin, Karl, 2010. "DSGE Models for Monetary Policy Analysis," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 7, pages 285-367 Elsevier.
  21. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  22. Henzel, Steffen & Hülsewig, Oliver & Mayer, Eric, 2009. "The price puzzle revisited: Can the cost channel explain a rise in inflation after a monetary policy shock?," Munich Reprints in Economics 19421, University of Munich, Department of Economics.
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