Entrepreneurs in Monetary Policy Transmission

Project: Research

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Although entrepreneurs bare a significant fraction of the aggregate economic fluctuations, their role in the transmission of monetary policy to aggregate demand is not yet well explored. How much do they contribute to the transmission? More importantly, what makes them contribute that much/little? To answer these questions, we need a structural model.In our project, we build the first Heterogeneous Agent New Keynesian (HANK hereafter) model that has an entrepreneur sector on top of the workers and listed firms. Our model highlights four distinct features of the entrepreneurs: (1) they are wealthier than workers, (2) they consume like workers and invest like firms, (3) they rely on external financing that is subject to collateral constraints, and (4) their business income is very sensitive to monetary policy shocks. The first three features are standard in macrocosmic models that do not focus on business cycles, while the last one is entirely new.We conjecture that these four features are crucial for entrepreneurs’ role in monetary policy transmission. Here are the reasons. (1) More income and wealth allow entrepreneurs to have a larger share in aggregate demand on average. (2) Access to both consumption and investment doubles the channels through which monetary policy can affect their demand for goods. (3) Collateral constraints make their consumption and investment decisions more dependent on cash flow. (4) Business income is their primary source of cash flow.To verify our conjecture, we will calibrate the model to match data. The steady-state income and wealth distributions match PSID and SCF surveys. The marginal propensities to consume (MPC) are from natural experiments in the literature. The income and consumption responses of workers and entrepreneurs to monetary policy shocks match the CEX survey, while the investment responses of listed firms match the Compustat survey.We will demonstrate the answer to our research questions in two steps: (1) decompose the impulse responses of aggregate demand along multiple dimensions, (2) compare the scenarios in which one of the four entrepreneur features is absent to our baseline model. The results would enrich our understanding of monetary policy in academia as well as help improve the conduct of monetary policy for policymakers.


Project number9048189
Grant typeECS
Effective start/end date1/01/21 → …