Inflation Dynamics in a Model with Firm Entry and (Some) Heterogeneity

Abstract

We analyse the incidence of endogenous entry and firm TFP-heterogeneity on the response of aggregate inflation to exogenous shocks. We build up an otherwise standard DSGE model in which the number of firms is endogenously determined and firms differ in their steady state level of productivity. This splits the industry structure into firms of different sizes. Calibrating the different transition rates, across firm sizes and out of the market we reproduce the main features of the distribution of firms in Spain. We then compare the inflation response to technology, interest rate and entry cost shocks, among others. We find that structures in which large (more productive) firms predominate tend to deliver more muted inflation responses to exogenous shocks.

Keywords: firm dynamics, industrial structure, inflation, business cycles

JEL Classification: E31, E32, L11, L16