Entry Dynamics as a Solution to the Puzzling Behaviour of Real Marginal Costs in the Ghironi-Melitz Model

Abstract

The work of Ghironi and Melitz (2005) is at the frontier of international real business cycle (IRBC) models with heterogeneous firms. In their model, the dynamic behaviour of real marginal costs is puzzling: a positive technology shock hitting the home country makes it permanently less cost-effective than the foreign economy. Wages grow more than profits during booms and the labour share in GDP is counterfactually procyclical. Entry by new firms is crucial in delivering this result. It is sufficient to posit that technology improvements are more efficacious in manufacturing than in the "production of new firms" for the labour share and real marginal costs to become countercyclical, consistently with empirical evidence. Once I introduce tradable capital goods and endogenous labour supply, the two models are on average equally good in replicating the empirical moments typically considered in the IRBC literature.

Keywords: international real business cycles, firm heterogeneity, firm entry dynamics, real marginal costs, labour share

JEL Classification: F12, F41