A new research paper published by the Federal Reserve’s Finance and Economics Discussion Series examines how fluctuations in business formation and destruction influence inflation and the effectiveness of monetary policy. The study extends a standard New Keynesian model to allow for endogenous entry and exit of firms and heterogeneous producers. It finds that a decline in the number of producers exerts upward pressure on inflation and can account for roughly half of the missing deflation observed after the Great Recession. The research also shows that changes in firm entry create an intertemporal trade‑off for policy makers: a contractionary shock reduces employment and inflation immediately, but later causes inflation to overshoot as entry falls and exit rises. The paper is available through the Federal Reserve’s website (DOI: 10.17016/FEDS.2026.003).
https://www.federalreserve.gov/econres/feds/firm-dynamics-inflation-and-the-transmission-of-monetary-policy.htm
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