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Firm Entry, Inflation and the Monetary Transmission Mechanism

Vivien Lewis () and Céline Poilly ()

No 2011004, LIDAM Discussion Papers IRES from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES)

Abstract: This paper estimates a business cycle model with endogenous firm entry by matching impulse responses to a monetary policy shock in US data. Our VAR includes net business formation, profits and markups. We evaluate two channels through which entry may influence 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 firm 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 inflation. While the proposed model does a good job at matching the observed dynamics, it generates insufficient volatility of markups and profits. Estimates of standard parameters are largely unaffected by the introduction of firm entry. Our results lend support to the variety effect; however, we find no evidence for the competition effect.

Keywords: entry; inflation; monetary transmission; monetary policy; extensive margin (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Pages: 34
Date: 2011-02-08
New Economics Papers: this item is included in nep-cba, nep-ent, nep-mac, nep-mic and nep-mon
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Working Paper: Firm entry, inflation and the monetary transmission mechanism (2011) Downloads
Working Paper: Firm Entry, Inflation and the Monetary Transmission Mechanism (2011) Downloads
Working Paper: Firm Entry, Inflation and the Monetary Transmission Mechanism (2011) Downloads
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