Monetary Policy and Welfare with Heterogeneous Firms and Endogenous Entry

Abstract

This paper studies monetary policy and welfare in a sticky wage New Keynesian model with heterogeneous firms and endogenously variable markups. We show that stabilizing nominal wages is optimal only when product creation is based on an instantaneous zero‐profit condition and when the aggregate markup is constant. A constant markup requires strong selection effects generated by a Pareto firm‐level productivity distribution. When product creation is based on a dynamic zero‐profit condition optimal monetary policy accounts for the distribution of firms and the welfare loss from stabilizing nominal wages is between and 0.2% of steady‐state consumption.