Monetary Policy and Business Cycles with Endogenous Entry and Product Variety

58 Pages Posted: 26 Jul 2012 Last revised: 27 Jul 2022

See all articles by Florin Bilbiie

Florin Bilbiie

Université Paris I Panthéon-Sorbonne

Fabio Pietro Ghironi

University of Washington

Marc J. Melitz

Centre for Economic Policy Research (CEPR); Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 2007

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.

Suggested Citation

Bilbiie, Florin O. and Ghironi, Fabio Pietro and Melitz, Marc J. and Melitz, Marc J., Monetary Policy and Business Cycles with Endogenous Entry and Product Variety (June 2007). NBER Working Paper No. w13199, Available at SSRN: https://ssrn.com/abstract=2117717

Florin O. Bilbiie (Contact Author)

Université Paris I Panthéon-Sorbonne ( email )

12 place du Panthéon
Paris, 75005
France

Fabio Pietro Ghironi

University of Washington ( email )

Department of Economics
Box 353330
Seattle, WA 98195-3330
United States
206-543-5795 (Phone)

HOME PAGE: http://faculty.washington.edu/ghiro

Marc J. Melitz

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-8297 (Phone)
617-417-6536 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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