Endogenous Firm Entry and the Supply-Side Effects of Monetary Policy
(joint with Seung Joo Lee and Zhenghua Qi)Submitted
Abstract: We present a model of business cycles with endogenous firm entry. In our framework, short-term supply shifts driven by new firm entries become a crucial factor in driving the economy's response to shocks, regardless of whether those shocks originate from the 'supply' or 'demand' blocks. Specifically, an uptick in aggregate demand triggers a cycle of increased firm entry, thereby enhancing aggregate supply and, in turn, further boosting demand through greater purchases of equipment by new entrants. Monetary policy becomes especially powerful, as it simultaneously impacts aggregate demand and the entry decisions of financially constrained firms. This effect is particularly noticeable in economies with a significant potential for new firm entries. Our analytical approach characterizes equilibrium firm entry as a function of the 'policy room', a sufficient statistic related to the effectiveness of monetary policy interventions in both the model and the data.
Recommended citation: Dordal i Carreras, Marc, Seung Joo Lee, and Zhenghua Qi. “Endogenous Firm Entry and the Supply-Side Effects of Monetary Policy.” Working Paper (2024). http://marcdordal.github.io/files/WP_Firm_Entry_Supply_side_MP.pdf