This paper estimates a business cycle model with endogenous firm and product entry. We evaluate how the extensive margin affects structural parameters and the relative importance of different frictions in the monetary transmission mechanism. To this end, we minimise the distance between the impulse responses of selected US variables to a monetary policy shock in the model and in an identified vector autoregression model. Our VAR contains net firm entry and profits in addition to the usual macroeconomic aggregates. The proposed model, which assumes the same type of adjustment costs for entry as for capital investment, does a good job at matching the observed dynamics. Investment adjustment costs at both margins are substantial. Working capital plays an important role in replicating the response of markups. Price rigidities are smaller than in an estimated model without entry, while wage rigidities are stronger. Our results lend support to the variety effect. We find no evidence of strategic interactions between firms
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