Monetary Policy and Endogenous Market Structure in a Schumpeterian Economy

In this study, we develop a monetary Schumpeterian growth model with endogenous market structure (EMS) to explore the e¤ects of monetary policy on the number of …rms, …rm size, economic growth and social welfare. EMS leads to richer implications and di¤erent results from previous studies in which market structure is exogenous. In the short run, a higher nominal interest rate leads to lower growth rates of innovation, output and consumption and also smaller …rm size due to a reduction in labor supply. In the long run, an increase in the nominal interest rate reduces the equilibrium number of …rms but has no e¤ect on economic growth and …rm size because of a scale-invariant property of the model as a result of entry and exit of …rms. Although monetary policy has no long-run e¤ect on economic growth, an increase in the nominal interest rate permanently reduces the levels of output, consumption and employment. Taking into account transition dynamics, we …nd that social welfare is decreasing in the nominal interest rate. Given that a zero nominal interest rate maximizes welfare, Friedman rule is optimal in this economy. JEL classi…cation: O30, O40, E41