Finance and Economics Discussion Series (FEDS)
January 2026
Firm Dynamics, Inflation, and the Transmission of Monetary Policy
Abstract:
I study how fluctuations in business formation and destruction affect inflation and the transmission of monetary policy. To do this analysis, I extend a New Keynesian model to include endogenous business formation and destruction and heterogeneous producers. A decline in the number of producers puts upward pressure on inflation, and I find that this mechanism can explain about half of the missing deflation following the Great Recession. I then study the transmission of monetary policy in this framework. I show that endogenous fluctuations in entry generate an intertemporal trade-off in monetary policy; a contractionary shock leads employment and inflation to decline on impact, but inflation later overshoots, as the shock also causes a decline in entry and an increase in exit.
DOI: https://doi.org/10.17016/FEDS.2026.003
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.