Entry, Exit, Firm Dynamics, and Aggregate Fluctuations

Do firm entry and exit play a major role in shaping aggregate dynamics? Our answer is yes. Entry and exit propagate the effects of aggregate shocks. In turn, this results in greater persistence and unconditional variation of aggregate time-series. These are features of the equilibrium allocation in Hopenhayn (1992)'s model of equilibrium industry dynamics, amended to allow for investment in physical capital and aggregate fluctuations. In the aftermath of a positive productivity shock, the number of entrants increases. The new firms are smaller and less productive than the incumbents, as in the data. As the common productivity component reverts to its unconditional mean, the new entrants that survive become more productive over time, keeping aggregate efficiency higher than in a scenario without entry or exit.