Supply Shocks in a Heterogeneous-Firm New Keynesian Model: The Entry Multiplier
We study productivity shocks in a New Keynesian model with endogenous entry, selection, and nominal rigidities. Adjustment along the extensive margin fundamentally alters the transmission of TFP shocks. Under sticky prices, productivity disturbances generate a large “entry multiplier”: firm-entry-exit responds much more strongly than under flexible prices, even when output is allocatively efficient to first order. Introducing wage stickiness breaks this neutrality. Adverse TFP shocks reduce profits, trigger exit, and generate a negative output gap while remaining inflationary. Productivity shocks therefore behave as true supply shocks, without resorting to ad hoc cost-push or markup disturbances. Unlike standard markup shocks, TFP shocks in our framework imply procyclical profits and entry, consistent with the data. When wages are sufficiently sticky, expansionary monetary policy raises entry, closes the negative output gap, and improves welfare. The model remains analytically tractable and isomorphic to the standard New Keynesian framework, with entry and selection appearing as simple wedges.
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Copy CitationFlorin O. Bilbiie and Marc J. Melitz, "Supply Shocks in a Heterogeneous-Firm New Keynesian Model: The Entry Multiplier," NBER Working Paper 28258 (2020), https://doi.org/10.3386/w28258.Download Citation
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