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OPTIMAL MONETARY POLICY AND FIRM ENTRY

Published online by Cambridge University Press:  30 August 2012

Vivien Lewis
Vivien Lewis*
Affiliation:
Ghent University and IMFS, Goethe University Frankfurt
*
Address correspondence to: Vivien Lewis, Center for Economic Studies, Catholic University Leuven, Naamsestraat 69, 3000 Leuven, Belgium; e-mail: [email protected]; URL: http://sites.google.com/site/vivienjlewis.
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Abstract

This paper characterizes optimal monetary policy in an economy with endogenous firm entry, a cash-in-advance constraint, and preset wages. Firms must make profits to cover entry costs; thus the markup on goods prices is efficient. However, because leisure is not priced at a markup, the consumption–leisure trade-off is distorted. Consequently, the real wage, hours, and production are suboptimally low. Because of the labor requirement for entry, insufficient labor supply also implies that entry is too low. This paper shows that in the absence of fiscal instruments such as labor income subsidies, the optimal monetary policy achieves higher welfare under sticky wages than under flexible wages. The policy maker uses the money supply instrument to raise the real wage—the cost of leisure—above its flexible-wage level, in response to expansionary shocks to productivity and entry costs. This increases labor supply, expanding production and firm entry.

Keywords

EntryOptimal Monetary PolicySticky Wages
Type
Articles
Information
Macroeconomic Dynamics , Volume 17 , Issue 8 , December 2013 , pp. 1687 - 1710
Copyright
Copyright © Cambridge University Press 2012 

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