DP15583 Aggregate-Demand Amplification of Supply Disruptions: The Entry-Exit Multiplier

Author(s): Florin Ovidiu Bilbiie, Marc J Melitz
Publication Date: December 2020
Date Revised: June 2021
Keyword(s): Aggregate Demand and Supply, COVID-19, Entry-Exit, Recessions, sticky prices, Variety
JEL(s): E3, E4, E5, E6
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15583

Due to its impact on nominal firm profits, price rigidity amplifies the response of entry and exit to adverse supply shocks, such as COVID-19. This "entry-exit multiplier" triggers substantial magnification of the welfare losses due to negative supply shocks---even in an efficient-entry benchmark. In addition to those second-order effects, price rigidity also induces first-order amplification under external returns, when entry is no longer efficient. Endogenous entry-exit thus radically changes the consequences of nominal rigidities: in addition to the aggregate-demand amplification of supply disruptions, it also reconciles the response of hours worked across the benchmark New Keynesian and RBC models.