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Firm Entry, Inflation and the Monetary Transmission Mechanism

Author

Listed:
  • Vivien LEWIS

    (Ghent University and Goethe University Frankfurt, IMFS)

  • Céline POILLY

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, IMMAQ, 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.

Suggested Citation

  • Vivien LEWIS & Céline POILLY, 2011. "Firm Entry, Inflation and the Monetary Transmission Mechanism," LIDAM Discussion Papers IRES 2011004, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    • Handle: RePEc:ctl:louvir:2011004
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    File URL: http://sites.uclouvain.be/econ/DP/IRES/2011004b.pdf
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    References listed on IDEAS

    as
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    2. Lilia Cavallari, 2012. "Modelling Entry Costs: Does It Matter For Business Cycle Transmission?," Working Papers 0712, CREI Università degli Studi Roma Tre, revised 2012.

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    More about this item

    Keywords

    entry; inflation; 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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