Aggregate-Demand Amplification of Supply Disruptions: The Entry-Exit Multiplier

Due to its impact on nominal firm profits, price rigidity amplifies the response of entry and exit to supply shocks. When those supply shocks are negative, such as those following supply chain disruptions, this “entry-exit multiplier” substantially magnifies the associated welfare losses—especially when wages are also rigid. This is in stark contrast to the benchmark New Keynesian model (NK), which predicts a positive output gap in response to that same shock under the same monetary policy. Endogenous entry-exit thus radically changes the consequences of nominal rigidities. In addition to the aggregate-demand amplification of supply disruptions, our model also reconciles the response of hours worked across the NK and RBC models. And unlike the standard NK model, our model can also be used to evaluate how monetary expansions can alleviate or even eliminate the negative output gap induced by supply disruptions.