The role of firm entry and firm heterogeneity for monetary and fiscal policy

• Applicant: Dr. Wolfgang Lechthaler, Ph.D.
• Subject Area: Economic Theory
• Term: from 2013 to 2015
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 228366685

In the monetary business-cycle literature, the role of the extensive margin in labor markets, i.e., the hiring and firing of workers, has been analyzed extensively. When it comes to product markets, however, the role of the extensive margin, i.e., the market entry and exit of products, still remains under-researched. One overriding and material shortcoming of existing models that analyze product entry and exit is their failure to account for the important empirical fact that the market share of new products is much smaller than the market share of established products.We propose to develop a monetary business-cycle model with heterogeneous firms that accounts for this fact. In our model, new products will be produced less efficiently than established products, and the production efficiency of formerly new products improves in the course of time. Preliminary work suggests that in models of this type, the aggregate productivity is endogenous and the business-cycle dynamics of inflation and output are grossly affected by its composition. The compositional effect arises naturally from product entry and captures that over time, resources are allocated from less to more productive product lines.We will use our monetary business-cycle model with heterogeneous firms and endogenous aggregate productivity to analyze various aspects of fiscal and monetary policy. In contrast to existing models in which aggregate productivity is exogenous, our model will allow us to trace out the impact of fiscal and monetary policy on the level of aggregate productivity. Hence, it will allow us to understand how these policies influence the path of aggregate productivity back to its normal level in the wake of a great recession like the one that we currently observe, and this is an urgent matter.

• DFG Programme: Research Grants
• Participating Person: Dr. Henning Weber