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Abstract

This paper explores a new channel for the transmission of monetary policy through the extensive margin. In this paper, a shock to money induces firms to enter by affecting a measure of Tobin's Q: the ratio of expected future profits to entry costs. In a dynamic stochastic general equilibrium setting, though, optimal consumption smoothing limits the flow of entering firms. As a result, the model generates positively correlated, persistent and hump-shaped responses of output, consumption and firm entry to monetary shocks, as observed in the data. This is obtained via an endogenous source of inertia and despite minimal nominal rigidities, as only one-time entry costs – as opposed to goods prices or wages – are assumed to be sticky.

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