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Monetary policy and endogenous market structure in a Schumpeterian economy

Chu, Angus C. and Ji, Lei (2012): Monetary policy and endogenous market structure in a Schumpeterian economy.

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Abstract

In this study, we develop a monetary Schumpeterian growth model with endogenous market structure (EMS) to explore the effects of monetary policy on the number of firms, firm size, economic growth and social welfare. EMS leads to different results from previous studies in which market structure is exogenous and richer implications on transitional dynamics. In the short run, a higher nominal interest rate reduces the growth rates of innovation, output and consumption and also decreases firm size due to a reduction in labor supply. In the long run, an increase in the nominal interest rate reduces the equilibrium number of firms but has no steady-state effect on economic growth and firm size due to EMS. Although monetary policy has no long-run effect on economic growth, an increase in the nominal interest rate permanently reduces the levels of output, consumption and employment. Taking into account transition dynamics, we find that social welfare is decreasing in the nominal interest rate. Given that a zero nominal interest rate maximizes welfare, the Friedman rule is optimal in this economy.

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