Towards a theory of firm entry and stabilization policy

This paper studies the role of stabilization policy in a model where …rm entry responds to shocks and uncertainty. We evaluate stabilization policy in the context of a simple analytically solvable sticky price model, where …rms have to prepay a …xed cost of entry. The presence of endogenous entry can alter the dynamic response to shocks, leading to greater persistence in the e¤ects of monetary and real shocks. Entry a¤ects welfare, depending on the love of variety in consumption and investment, as well as its implications for market competitiveness. In this context, monetary policy has an additional role in regulating the optimal number of entrants, as well as the optimal level of production at each …rm. We …nd that the same monetary policy rule optimal for regulating the scale of production in familiar sticky price models without entry, also generates the amount of (endogenous) entry corresponding to a ‡ex-price equilibrium. JEL classi…cation: E22, E52, L16