Firm dynamics and markup variations: Implications for sunspot equilibria and endogenous economic fluctuations

This paper analyzes how the interaction between …rms’entry-and-exit decisions and variations in competition gives rise to self-ful…lling, expectation-driven ‡uctuations in aggregate economic activity and in measured total factor productivity (TFP). The analysis is based on a dynamic general equilibrium model in which net business formation is endogenously procyclical and leads to endogenous countercyclical variations in markups. This interaction leads to indeterminacy in which economic ‡uctuations occur as a result of self-ful…lling shifts in the beliefs of rational forward looking agents. When calibrated with empirically plausible parameter values and driven solely by self ful…lling shocks to expectations, the model can quantitatively account for the main empirical regularities characterizing postwar U.S. business cycles and for 65% of the ‡uctuations in measured TFP: Keywords: sunspots, business cycle, TFP, …rm dynamics, markup. I am indebted to Gadi Barlevy, Je¤ Campbell, Larry Christiano, Marty Eichenbaum, John Fernald, Jonas Fisher, Jim Hamilton, Rob Porter, Garey Ramey, Valerie Ramey, Sergio Rebelo, and Joseph Zeira for most valuable comments, suggestions and criticism. I thank Levon Barseghyan, Martin Bodenstein, Ariel Burstein, Ricardo di Ceccio, and Nadav Levy, and seminar participants at Northwestern University, Graduate School of Business at Columbia University, Harvard Business School, University of California San Diego, University of British Columbia, University of Illinois at Urbana-Champaign, University of Maryland, GSIA at Carnegie Mellon, Yale University, University of Pennsylvania, Hebrew University, and Tel-Aviv University for helpful suggestions and comments. Any remaining errors are my own. Financial support from the Eisner Fellowship of the Economics Department at Northwestern University and from Northwestern University’s Dissertation Year Fellowship is gratefully acknowledged. Seth Pruitt has provided excellent research assistance. yDepartment of Economics, Stanford University. [email protected].