Working Paper: NBER ID: w13199
Authors: Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz
Abstract: This paper studies the role of endogenous producer entry and product creation for monetary policy analysis and business cycle dynamics in a general equilibrium model with imperfect price adjustment. Optimal monetary policy stabilizes product prices, but lets the consumer price index vary to accommodate changes in the number of available products. The free entry condition links the price of equity (the value of products) with marginal cost and markups, and hence with inflation dynamics. No-arbitrage between bonds and equity links the expected return on shares, and thus the financing of product creation, with the return on bonds, affected by monetary policy via interest rate setting. This new channel of monetary policy transmission through asset prices restores the Taylor Principle in the presence of capital accumulation (in the form of new production lines) and forward-looking interest rate setting, unlike in models with traditional physical capital. We also study the implications of endogenous variety for the New Keynesian Phillips curve and business cycle dynamics more generally, and we document the effects of technology, deregulation, and monetary policy shocks, as well as the second moment properties of our model, by means of numerical examples.
Keywords: monetary policy; business cycles; endogenous entry; product variety
JEL Codes: E31; E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy (E52) | product prices (D49) |
| monetary policy (E52) | inflation dynamics (E31) |
| temporary interest rate cut (E43) | expected return on equity (G12) |
| expected return on equity (G12) | current consumption (E20) |
| monetary policy (E52) | firm value (G32) |
| endogenous product variety (O40) | New Keynesian Phillips curve (E12) |
| markup (Y60) | labor share in consumption output (E25) |