Working Paper: CEPR ID: DP5376
Authors: Paul R. Bergin; Giancarlo Corsetti
Abstract: This paper explores the role of stabilization policy in a model where firm entry responds to shocks and uncertainty. We evaluate stabilization policy in the context of a simple analytically solvable sticky price model, where firms have to prepay a fixed cost of entry. The presence of endogenous entry can alter the dynamic response to shocks, leading to greater persistence in the effects of monetary and real shocks. Entry affects welfare, depending on the love of variety in consumption and investment, as well as its implications for market competitiveness. In this context, monetary policy has an additional role in regulating the optimal number of entrants, as well as the optimal level of production at each firm. We find that the same monetary policy rule optimal for regulating the scale of production in familiar sticky price models without entry, also generates the amount of (endogenous) entry corresponding to a flex-price equilibrium.
Keywords: Market Dynamics; Monetary Policy; Productivity
JEL Codes: E22; E52; L16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary Policy (E52) | Firm Entry (L26) |
| Reduction in Entry Costs (D49) | Number of Firms Entering the Market (L26) |
| Number of Firms Entering the Market (L26) | Overall Output (C67) |
| Lack of Effective Stabilization Policies (E63) | Higher Product Prices (D49) |
| Lack of Effective Stabilization Policies (E63) | Lower Average Scale of Activity among Existing Firms (L25) |
| Lower Average Scale of Activity among Existing Firms (L25) | Decrease in Average Number of Firms (L19) |
| Absence of Stabilization Policies (E63) | Lower Unconditional Expected Welfare (D69) |
| Greater Preference for Variety in Consumption (D11) | Welfare Gains from Stabilization (D69) |