Optimal Stabilization Policy with Endogenous Firm Entry

We study optimal monetary stabilization policy in a dynamic stochastic general equilibrium model where money is essential for trade and …rm entry is endogenous. We do so when all prices are ‡exible and also when some are sticky. Due to an externality a¤ecting …rm entry, the central bank deviates from the Friedman rule. Calibration exercises suggest that the nominal interest rate should have been substantially smoother than the data if preference shocks were the main disturbance and much more volatile if productivity was the driving shock. This result is a direct consequence of policy actions to control entry. The paper has bene…tted from comments by participants at several seminar and conference presentations in particular Sanjay Chugh, Allen Head and Huberto Ennis. We thank the Federal Reserve Banks of Cleveland, Minneapolis and St. Louis, CES in Munich and the Kellogg Institute at the University of Notre Dame for research support.