Research

In this paper, we explore the response of optimal monetary policy to uncoordinated trade policies, namely foreign tariff shocks. We provide a model of an open economy with heterogeneous firms and nominal rigidities where foreign tariff shocks induce a sluggish adjustment in the labor market between domestic and exporter firms. When wages are sticky, a foreign tariff hike leads to an expansionary monetary policy as optimal response to sustain labor demand in the domestic market. We show that the dispersion of firm productivity governs the reallocation of resources in the labor market and determines the extent of the monetary policy response to external tariff shocks.

Do recessions cleanse the economy of its least productive firms? Using comprehensive administrative data on Portuguese firms from 2004 to 2023, we study exit selection over the business cycle. We document two main findings. First, low-productivity firms are more likely to exit during growth slowdowns, but we find no evidence of cleansing during recessions. Second, low-productivity firms are more likely to become zombies during recessions rather than exit. As a result, the cleansing and zombie effects operate in opposite directions in downturns, weakening the selection at the exit margin. We develop a model with endogenous entry, exit, and zombie firms that matches these empirical patterns and quantifies their implications for aggregate TFP growth. We show that zombie congestion during recessions dampens productivity-enhancing reallocation and lowers aggregate TFP.