Business Formation and Economic Growth Beyond the Great Recession

Aubhik Khan, Julia Thomas and Tatsuro Senga
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Julia Thomas: Ohio State University

No 1453, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We develop a model with endogenous entry and exit in an economy subject to non-stationary shocks to aggregate total factor productivity. Firms exhibit a life-cycle consistent with microeconomic data, and our model reproduces key moments of the empirical firm age and size distribution. In this setting, persistent shocks to trend growth can drive long term reductions in business formation. The economic consequences of a persistent decline in entry grow over time and, together with "wait-and-see" effects on aggregate capital investment, can compound and protract a productivity slowdown. We apply our model to understanding the last decade of U.S. economic activity, an episode marked by slow GDP growth and persistently low entry rates and business fixed investment in the aftermath of the Great Recession. Firms vary in the permanent and transitory components affecting their productivity and in their capital stocks, and their capital adjustments are subject to one period time-to-build, alongside convex and nonconvex costs. Thus, the economy's aggregate state includes a distribution of firms over productivity and capital, and changes in this distribution have a persistent influence on economic activity. Epstein-Zin preferences and a time-varying relative price of capital goods combine to accommodate countercyclical risk premia capable of driving large changes in firm values. Following a persistent shock to trend growth, equilibrium movements in firms' stochastic discount factors imply long-run reductions in the value of entry. The resulting declines in new business formation propagate the shock's effects on investment and GDP, slowing aggregate recovery.

Date: 2019
New Economics Papers: this item is included in nep-bec, nep-dge, nep-ent, nep-mac and nep-sbm
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