Frictional Entry and the Long-Run Transmission of Productivity Shocks

Abstract

This theoretical paper presents a framework for analyzing the long-run effects of productivity shocks that incorporates frictional entries in a standard macroeconomic model. In comparison to the case of frictionless entries, the framework yields two main results. First, the model predicts a negative response of hours even under log utility. This paradoxical result is rationalized by the existence of a sluggish response of income to profit changes. Second, the presence of frictional entries mitigate the effect of productivity shocks in the case of logarithmic preferences, constant relative risk aversion preferences and Greenwood–Hercowitz–Huffman preferences. Consequently, this suggests that models equipped with the standard zero-profit condition overestimate the amplification channel arising from firms’ entry.