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This PDF is a selection from a published volume from the National Bureau of Economic Research Volume Title: NBER Macroeconomics Annual 2007, Volume 22 Volume Author/Editor: Daron Acemoglu, Kenneth Rogoff and Michael Woodford, editors Volume Publisher: University of Chicago Press Volume ISBN: 978-0-226-00202-6 Volume URL: http://www.nber.org/books/acem07-1 Conference Date: March 30-31, 2007 Publication Date: June 2008 Chapter Title: Comment on "Monetary Policy and Business Cycles with Endogenous Entry and Product Variety" Chapter Author: Julio J. Rotemberg Chapter URL: http://www.nber.org/chapters/c4092 Chapter pages in book: (p. 367 - 375) Comment Harvard Julio J. Rotemberg, Business School and NBER a useful se and Melitz (BGM) provides 2006 paper. The earlier paper introduced a tractable entry was competition model where dynamic monopolistic in an attractive manner. By paying an entry fee, any firm could handled This paper by Bilbiie, Ghironi, quel to their already influential become earlier a symmetric monopolistically competitive the case where papers had considered producer. While many there was a fixed cost to pay each period, Bilbiie, firm needed that an imperfectly competitive and Melitz fixed costs and Ghironi, (2006) neglected period-by-period once. to costs that all had be For the fixed paid just supposed describing behavior of entrants, this assumption has considerable this model difficulty with interpreting One empirical is that new however, try, slowly become over a priori appeal. as amodel of en tend to be small firms that grow only this is a model where firms immediately entrants time. By contrast, as large as the typical firm after they pay their entry cost. BGM as one where to thus prefer firms are increasing interpret this model the number of varieties that they sell and where the fixed cost is the cost of adding a variety. This interpretation has an important side benefit, on it that macroeconomists' attention focuses the indubitable namely fact that most firms sell a variety of different products. The current paper extends the BGM framework by letting firms have toward realism that Iwelcome) and uses the result (a step rigid prices to model of the consequences ing study monetary policy. This has the some to of of how consequences advantage bringing light unexpected one models in sticky price models. entry costs and the labor market These lessons pirical model, number failures. BGM are em particularly well illustrated by two of the model's The first is that, at least in the benchmark version of the conclude of firms that monetary should reduce the expansions For the case of the number of firms, (or products). 368 Rotemberg (2005) show that identified monetary Bergin and Corsetti policy shocks in a VAR increase the number of firms (and this result has been repli cated by Lewis in is that, for output expansions [2006]). The second shocks, the current BGM paper features unrealis movements inmarkups. tically large countercyclical as discussion is sim follows. First, I show that amuch My organized can a in is with model of model entry explain why entry pler procyclical duced by technology are that is, in amodel where output fluctuations I discuss in the markup of final goods. Second, the cyclical behavior of the number of new concerning no technology shocks, the result of variations some evidence on the is a great deal scarcer than the evidence This evidence products. at number of firms, but, as suggested is of least earlier, probably equal One for macroeconomists. aspect of this evi importance interesting is that, at least for the data I have been able to find, the number of is not very strongly procyclical. Third, I discuss one of the im products reasons of this model the benchmark version has entry portant why dence in response is modeled falling market tomonetary policy expansions. in such a way that real wages This is that the labor are much are in reality. Last, I show that this weakness cyclical than they the also explains the finding that markups labor market eling to technology in response shocks. sively countercyclical 1 A Simple Model Suppose Y\ = of the Equilibrium that final producers have Number a production more pro inmod are exces of Firms function given by (l) (M;)? this firm's Y\ represents output by firm i at twhile M\ represents mar use of materials at t. In the simplest case, there is an economy-wide so that ket for materials where ' i and q{ is the output of in Mt equals the total available materials earns a are produced with firm ;. Materials termediate labor, which is to labor The wage wt. q{ produce requirement where L{ = q{[x + a(q{-qY] x is a constant. While this may seem aU-shaped it has the benefit of form, yielding to minimum xwr average cost equal where like an unusual average functional cost function with 369 Comment to cost is then equal Marginal [x+ a(q{ qf + 2a(q[ q)q[]wt. that the price of the intermediate input competition implies enter whenever this price exceeds av Firms cost. then equals marginal at effi erage cost. This ensures that all intermediate good firms produce cient scale qand that the price of the intermediate good vt is given by Perfect = vt xwr The number nt = intermediate of firms producing nt equals MJq. From both the point of view the final goods producers, are according goods produced = and from the point of view of to one where final of workers this model Y\ goods is equivalent to (L;/*)?. cost of the final good is zvtL\/(olY\). In either case, marginal is that increases An immediate of this model implication lead to increases Since the technologies are held constant goods the result in output of firms producing intermediate inputs. both the final and intermediate for producing in the number of reductions Thus, this model rise if there was in output must be of the final goods producers. that the number of intermediate firms would in this exercise, in the markup this increase predicts an expansionary monetary policy and final goods pro that matching the ducers had sticky prices. It should be noted, however, a more com actual dynamics of entry probably requires substantially as in Lewis (2006), one probably needs further ad plex model because, justment costs. I return to this issue in the following discussion. 2 How Does It is well of Products Vary Cyclically? that the number of firms is quite procyclical. But be are the firms for small, importance of this phenomenon un and remains aggregate output, aggregate employment I thus applaud this paper's emphasis on the number of products cause most pricing, known. known the Number new produced by any given firm. Unfortunately, about the time-series of product properties relatively variety. A little is known recent study by new in breaks this area, and finds (2007) ground is quite that the number of UPC codes found in consumers' purchases this includes six of data However, (of years procyclical. study only Broda and Weinstein 370 Rotemberg 1999-2003 involves consecutive observations). only the period it does include one recession, the 2001 recession may have been to the collapse of the dot.com bubble. itwas connected special, because on this issue. sources of information I thus consider two additional which While The first is data assembled (2003) (1990) and Axarloglou by Devinney in the pages of the of new products that were announced data cover the period Wall Street Journal.1 The quarterly Devinney cover while the data the period 1984:1 1975:1-1984:4, (2003) Axarloglou are used by these two researchers 1994:2. Unfortunately, the methods on the number that identical, though their series behave similarly over the period as a as common. indicator in have These well obtained data, cyclical they GDP the method of (2003), are depicted Rotemberg by detrending using in figure 5C2.1. not to The plot does not reveal strong responses of product introductions or a nor af do they involve either the 1990 2001 recession, large increase the Devinney ter the 1974 recession. The correlation between (1990) data on the is and introduction GDP of actually -0.34, cyclical product log on data the that between while the Axarloglou (2003) log of introduc tions and cyclical GDP 0.04 The correlations is -0.40. the change between in -1-"-p6 I' 002J ^ Devinney(1990) \ v' * "?'02i//v / Cyclical GDP I I , log -0.04-JJ -0.06J '0-08 -j 111 111 j 11111111111 j 76 Figure 5C2.1 Cyclical GDP 78 \A \ ' h (2003) Axarl?9lou \l [ [ 1111111111111111111111111111111111111111111 80 and Log of Wall 82 Street i |3 I j 'h\\ h i 'I\ I // \I rl/Vl \/ /V V *" \;/ a/ \r 84 Journal New 86 Product 88 90 Announcements 111 1 [ 111111 f- 92 371 Comment and the change in cyclical GDP is -0.57 in the the log of introductions it is 0.65 in the latter. This latter finding provides early period while some support for the idea that product introductions seems weak for this proposition the overall evidence are procyclical, but from these data.2 series on the number of available readily available of a certain type is available from Ward's Automobile Reports. products in each calendar year by This publication lists new car registrations An even more A nameplate is a sub-brand, like the Chevrolet Impala or a sub-brand has two different body Mercury Cougar. When particular as a and sedan (such types they appear as different nameplates. wagon), "nameplate." in trim, engine, or options do not such as differences differences, as in a particu The number of nameplates appear separate nameplates. a measure lar year is thus crude of product variety, but it has the advan and of available easy to define. tage being readily Other Data while on is not available from 1955, foreign automobiles consistently on cars data is. Figure 5C2.2 thus shows the logarithm U.S. -made as well as the measure of U.S. nameplates of cyclical GDP The correlation series is fairly low. between these previously. 0.22 using the 1955-2005 it whereas sample, equals only 0.08 if of the number discussed It equals one removes els where the 1959 observation. the variety My conclusion of final output is procyclical 5.0-,-r 4 8 ANameplates 4.0-? ii I \l 55 .06 04 1 (Cyclical .-.04 /log GDP V 3.8vS.o-| exploring, ^AVV \j \/ \l 1/ are worth 1 Log# US [ A *.2- from this is that mod V ' --.06 i i i i | i i i i | i i i i | i i i i | i i i i | i i i i | i i i i | i i i i | i i i i | i i i i p~.Uo Figure 5C2.2 Cyclical tions GDP 60 65 70 and Log of the Number 75 80 85 of U.S. Automobile 90 95 Nameplates 00 in New 05 Registra 372 Rotemberg but that the relationship between appears to be fairly complex. 3 Entry and Monetary Inow provide so as to show Policy product and business variety cycles in the BGM Model a simplified of some aspects of the BGM model exposition that entry falls that an important reason for its conclusion to market. To il is due its model of the labor expansions after monetary to enter in a model with a fixed the incentives lustrate this, I consider as the labor market ismodeled number of firms and I show that, when in BGM, this incentive falls when output rises. to enter, it that, if a firm were suppose for as long as receive a fixed fraction of the total profits available would in 8 of disappearing it expects a probability the firm stays alive. Suppose a amount cost labor. that consists of fixed of and the each period entry To calculate this incentive if is then attractive Entry (2) ?tBpd-8)]!(^y^+^^/? where/? is a constant while irt and Ct represent respectively. With Yt = Ct and constant returns, = = ir, Ct(Pt MC,)/Pt 1/?l() C,(l real profits |xf as Pt/MCr and consumption, at t are (3) cost at t and MCt is marginal the markup defining where profits the second At the same is based on equality time, the production function = c, mr implies |x, is given that the markup by =-=-. (4) wt wt Now let variables state. Differentiating *= ("i^rjft so that profits we obtain with tildes denote log deviations around a steady (3) gives +c" rise with output and with markups. Differentiating (4), 373 Comment = _ 1-a ~ t?? & which ' ct, implies / -1 \ \|UL 1/ 1-a ' f L ^-1)J 1. ' that profits fall when the real wage rises, while they rise > 1. This condition au. as is for necessary output long profits to in markups. to changes in response be procyclical Since BGM assume that a = 1, this condition is always satisfied in their paper. This condi This shows as with tion is not sufficient, however. Profits rise only if the resulting real wage increases are suitably modest. that the aver Indeed, since they suppose = a 2 is less than while fall unless rise |jl 1, profits age markup wages less than output. The big question, then, is what deter considerably mines the real wage. a traditional is to suppose that real wages route, which amarginal make workers indifferent between increase in leisure and the can be afforded in increase that marginal consumption by giving up this leisure for work. While this assumption has not proved deleterious in BGM follow it proves quite problematic here. To see models, Keynesian individual such that instantaneous this, consider preferences utility is other New given by + JJL l/<p ?1-7 -+ x l + l/<p 1-7 With {Q->wt these preferences, = clearing labor market requires that x(Q1">. Differentiation = u>, a near a steady state then yields + (A 7)c(. that 7 = 1 so that the wage rises by at least 1 percent every time output rises by 1 percent. Lower values of the (or consumption) Frisch elasticity 9 accentuate this effect. Equation (3), on the other hand, even that fall when if rises, implies output wages profits only rise by the same percentage as output. With wages and rising profits falling, the in more so is to be that the incentive to enter violated, (2) equality likely BGM assume falls. The conclusion from this is that the incentive to enter can rise only 374 Rotemberg are only are suitably modest. In practice, real wages so the case where entry becomes more attractive can slightly procyclical, valid one. easily be the most empirically if increases inwages the results in this paper the contrast between assumes that She nominal (as opposed (2006). wages for goods) are rigid and finds that output rises after amon This discussion explains and those of Lewis to the prices is to suppose that entry costs involve the etary expansion. An alternative of whose prices are sticky. This is the route pursued by purchase goods and Corsetti (2006). As (2005) and Elkhoury and Mancini Griffoli Bergin as entry costs fall relative to the future value of profits, entry rises, long The point of my discussion, and BGM cover this case in an extension. in real wages might well make entry is that realistic changes however, even if all entry costs take the form of hiring additional labor. procyclical rise quickly with consump that real wages The model's implication, for the finding that markups is also responsible tion and employment, can be excessively to technology in response countercyclical see this, remember that in the BGM model with a variable firms, the total amount = L( Ntf of labor hired, Lt, is given shocks. To number of by + *L, each of Nt is the number of firms, Lf is the number of workers number of is the firms hires to produce t consumption goods, NE In this equa new firms (or products), and Zt is an index of technology. to needed reduce the number of employees tion, increases in technology to the amount of start a firm so as to keep the startup costs in proportion a given level of output. to produce labor needed where these lower la With sticky prices and without entry, increases in Zt usually firms of prices prevents The reason is that the stickiness bor demand. to so from selling a great deal more, produce they need fewer workers the quantity demanded.3 that new firms there is a countervailing effect, namely Here, however, be hired. In the workers that to additional this requires wish enter?and of this paper, total labor demand actually rises and, for the With a = this discussed earlier, pushes wages up considerably. falls a great deal. This effect 1, this is the same as saying that the markup can be reduced by making real wages respond less to output. However, costs itwould probably also help the model perform better if adjustment of were be a dampened added so that there would response entry to with small consistent from Aside shocks. relatively being technology calibration reasons 375 Comment a change would changes in entry, such modeling bor demand when improves. technology in la also avoid bursts Endnotes from a quarterly extracted (1990) data were plot in his paper. data underlying sent me the quarterly his analysis. aggregate 1. The Devinney Axarloglou kindly growth (1990) and Axarloglou introductions product where the number regressions rates of GDP as well. 3. Gali (1999) con that they find empirical (2003) emphasize and aggregate but they consider more output, on to depend is allowed of introductions lagged 2. Both Devinney between nections complex showed this effect Kostas to exist and gave empirically, this explanation. References Axarloglou, 29^8. K. 2003. The of new cyclicality 2005. Towards Bergin, P. R., and G. Corsetti. no. 11821. NBER Working Paper Cambridge, introductions. product of Business Journal a theory of firm entry and stabilization policy. MA: National Bureau of Economic Research. and M. J.Melitz. 2006. Monopoly and endogenous Bilbiie, F. O., F. Ghironi, power in dynamic stochastic Distortions and remedies. equilibrium: general Unpublished of Oxford, Boston College, and Princeton University University. Broda, C, and D. E.Weinstein. NBER implications. nomic Research. Devinney, Management Elkhoury, ing Paper Gali, plain T. M. Working 1990. New 2007. Product Paper no. creation and destruction: 13041. Cambridge, over products 76: the business MA: cycle. variety paper, Evidence National Journal Bureau of Product and price of Eco Innovation 7:261-73. 2006. Monetary Griffoli. M., and T. Mancini policy with no. 09/2006. Geneva: Graduate Institute of International J. 1999. Technology, employment, fluctuations? American aggregate and technical J. J. 2003. Stochastic Rotemberg, business Economic Review cycles. American Lewis, V. 2006. Macroeconomic tional Bank of Belgium Research fluctuations paper the business Economic Review cycle: Do technology 89 (1): 249-71. smooth progress, 93 (5): 1543-59. and 200610-13. firm entry. HEI Work Studies. trends, firm entry: Theory Brussels: NBB. and nearly and shocks ex distinct evidence. Na