LIMITED PARTICIPATION OR STICKY PRICES? NEW EVIDENCE FROM FIRM ENTRY AND FAILURES Lenno Uusküla*   Working Papers of Eesti Pank No 7/2008

Traditional models of monetary transmission such as sticky price and limited participation abstract from firm creation and destruction. Only a few papers look at the empirical effects of the monetary shock on the firm turnover measures. But what can we learn about monetary transmission by including measures for firm turnover into the theoretical and empirical models? Based on a large scale vector autoregressive (VAR) model for the U.S. economy I show that a contractionary monetary policy shock increases the number of business bankruptcy filings and failures, and decreases the creation of firms and net entry. According to the limited participation model, a contractionary monetary shock leads to a drop in the number of firms. On the contrary the same shock in the sticky price model increases the number of firms. Therefore the empirical findings support more the limited participation type of the monetary transmission.
JEL Code: E32, C32
Key words: monetary transmission, limited participation, sticky prices, firm entry, firm bankruptcy, structural VAR

* I want to thank Morten O. Ravn, Giancarlo Corsetti, Saverio Simonelli, Jeff Campbell, Zeno Enders and Alan Sutherland for their valuable suggestions, Thomas Bourke for help in getting the data. I am also grateful to the seminar participants at the European University Institute, and Eesti Pank, and conference participants at MAREM Conference in Bonn, International Conference on Economic Modeling in Berlin, EEA/ESEM conference in Milan, and Money, Macro and Finance (MMF) conference in London.

Author's e-mail address: lenno.uuskula@eui.eu

The views expressed are those of the author and do not necessarily represent the official views of Eesti Pank.

Contents

1. Introduction

2. Empirical methodology

3. Data

4. Empirical results

5. Robustness analysis

6. Limited participation model

6.1. Consumer problem

6.2. Final goods firm

6.3. Intermediate goods firms

6.4. Financial intermediary

6.5. Monetary authority

6.6. Market clearing conditions and the equilibrium

7. Model with pre-set prices

7.1. Consumer problem

7.2. Final goods firm

7.3. Intermediate goods firms

7.4. Monetary authority

7.5. Market clearing conditions

8. Calibration and results of the two models

9. Conclusions

References

Appendix

Limited Participation or Sticky Prices? New Evidence from Firm Entry and Failures, Working Papers of Eesti Pank No 7/2008 (PDF*)

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