Monetary Policy and Welfare with Heterogeneous Firms and Endogenous Entry

Cooke, Dudley; Damjanovic, Tatiana

Abstract

This paper studies the welfare consequences of monetary policy in a sticky-wage New Keynesian model with heterogeneous firms and endogenously variable markups. Firm heterogeneity affects the volatility of the aggregate markup and the welfare benefit to product variety because there are selection effects. We show that stabilizing nominal wages is optimal only when product creation is based on an instantaneous zero-profit condition and when the aggregate markup is constant. A constant markup requires strong selection effects generated by a Pareto firm-level productivity distribution. When product creation is based on a dynamic zero-profit condition optimal stabilization policy always accounts for the distribution of firms and the welfare loss from stabilizing nominal wages is 0.1 − 0.2 percent of steady state consumption.

Citation

Cooke, D., & Damjanovic, T. (2024). Monetary Policy and Welfare with Heterogeneous Firms and Endogenous Entry. Journal of Money, Credit and Banking, https://doi.org/10.1111/jmcb.13158

• Journal Article Type: Article
• Acceptance Date: Dec 14, 2023
• Online Publication Date: May 24, 2024
• Publication Date: May 24, 2024
• Deposit Date: Apr 29, 2024
• Publicly Available Date: May 25, 2026
• Journal: Journal of Money, Credit and Banking
• Print ISSN: 0022-2879
• Publisher: Wiley
• Peer Reviewed: Peer Reviewed
• DOI: https://doi.org/10.1111/jmcb.13158
• Keywords: Endogenous Entry; Heterogenous Firms; Optimal Monetary Policy; Variable
• Public URL: https://durham-repository.worktribe.com/output/2407823