[Séminaire Caen] Firm Selection, Productivity Distribution and Expectation-Driven Fluctuations

Abstract:
This paper shows how expectation-driven business cycle fluctuations can emerge from firm entry and selection rather than from aggregate externalities. To this end, I consider a standard RBC model with monopolistic competition and heterogeneous firms. The selection effect is driven by a productivity cut-off determined by a zero-profit condition while firm entry is characterized by new firms that are potentially different from incumbents, consistent with empirical evidence. I then characterize the local dynamics of the model and show that local indeterminacy, and therefore expectation-driven fluctuations, depends on a single sufficient statistic that summarizes a feedback loop between aggregate productivity and output. As a result, when new entrants are on average more productive than incumbents, this feedback is strong enough for expectations to generate business cycle fluctuations.