Monetary Policy and Firm Dynamics

TL;DR

This paper investigates how firm entry and exit dynamics influence the transmission of monetary policy, showing that firm-level responses can explain aggregate employment changes, but macro responses often mirror simpler models.

Contribution

It introduces a model combining firm dynamics with New-Keynesian frictions, providing insights into how firm entry and exit respond to monetary shocks.

Findings

Startup rates decline after monetary contraction

Exit rates increase following monetary tightening

Model qualitatively matches entry and exit responses

Abstract

Do firm dynamics matter for the transmission of monetary policy? Empirically, the startup rate declines following a monetary contraction, while the exit rate increases, both of which reduce aggregate employment. I present a model that combines firm dynamics in the spirit of Hopenhayn (1992) with New-Keynesian frictions and calibrate it to match cross-sectional evidence. The model can qualitatively account for the responses of entry and exit rates to a monetary policy shock. However, the responses of macroeconomic variables closely resemble those in a representative-firm model. I discuss the equilibrium forces underlying this approximate equivalence, and what may overturn this result.