1/2015 Lenno Uusküla. Firm turnover and inflation dynamics

Working Papers of Eesti Pank 1/2015

This paper examines the role of firm turnover in explaining inflation dynamics. I augment a New-Keynesian DSGE model with endogenous entry and exogenous stochastic exit and estimate with the Bayesian full information approach for the US economy. Results show that shocks to the entry cost explain more than half of the inflation variance at the business cycle frequencies. When it is cheap to create firms, the number of new firms goes up and inflation increases as labour intensive creation of firms pushes up the demand for labour. Only gradually, when the number of firms is high and the number of new firms goes down again, does inflation fall, as stressed by the standard mechanism for an increasing number of firms.

JEL Code: E32, C11, E23

DOI: 10.23656/25045520/12015/0017

Keywords: inflation, New-Keynesian Phillips curve, firm turnover

Author’s e-mail address: lenno.uuskyla [at] eestipank.ee

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The views expressed are those of the author and do not necessarily represent the official views of Eesti Pank or the Eurosystem.