Working Paper: CEPR ID: DP8564
Authors: Florin Ovidiu Bilbiie; Fabio Ghironi; Marc J. Melitz
Abstract: This paper builds a framework for the analysis of macroeconomic fluctuations that incorporates the endogenous determination of the number of producers and products over the business cycle. Economic expansions induce higher entry rates by prospective entrants subject to irreversible investment costs. The sluggish response of the number of producers (due to sunk entry costs and a time-to-build lag) generates a new and potentially important endogenous propagation mechanism for real business cycle models. The return to investment (corresponding to the creation of new productive units) determines household saving decisions, producer entry, and the allocation of labor across sectors. The model performs at least as well as the benchmark real business cycle model with respect to the implied second-moment properties of key macroeconomic aggregates. In addition, our framework jointly predicts procyclical product variety and procyclical profits even for preference specifications that imply countercyclical markups. When we include physical capital, the model can simultaneously reproduce most of the variance of GDP, hours worked, and total investment found in the data.
Keywords: business cycle propagation; entry; markups; product creation; profits; variety
JEL Codes: E20; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| productivity shocks (O49) | expected profits (D33) |
| expected profits (D33) | firm entry rates (L26) |
| productivity shocks (O49) | firm entry rates (L26) |
| economic expansions (E32) | firm entry rates (L26) |
| firm entry rates (L26) | product variety (L15) |
| firm entry rates (L26) | macroeconomic fluctuations (E39) |