Oil prices, firm entry, exit and aggregate output fluctuations

This dissertation consists of three chapters. The main focus of this dissertation is to investigate the effects of oil price increases on macroeconomic activity. More specifically, I analyze the effect of oil price increases on firm startups and firm exits. As the share of oil in production is small, standard real business cycle models have been criticized for their inability to explain the contractionary effects of oil price shocks. I show that including firm startups (entry) or exits can amplify the effects of energy price shocks and can lead to a bigger decline in output compared to standard models in the literature. This is a transmission channel which has not been explored in the literature and can be one of the potential explanations behind the observed link between oil price shocks and U.S. recessions.;In the first chapter "Oil Price Shocks and the Extensive Margin" I analyze the role of endogenous exits in a static heterogeneous firm model. In contrast to standard symmetric firm models where oil price shocks act as a negative productivity shock, in heterogeneous firm models aggregate productivity can increase due to an oil price shock. This is due to endogenous exit of the least productive firms post an oil price shock. In this model, aggregate output falls due to the decline in number of producing firms which dominates the productivity effect. The model also implies a higher responsiveness of output in a heterogeneous firm model when compared to a standard representative competitive firm model.;In the second chapter "Energy in a model of Firm Entry" I try to analyze the transmission channels of oil price increase in a dynamic stochastic general equilibrium model with firm entry. Inclusion of firm entry amplifies the effects of energy price shocks and can generate bigger decline in output compared to standard real business cycle models. In this respect, I also present evidence from U.S. firm level data which shows that increasing energy prices have a significant negative effect on firm entry. For my third essay "Oil Price Shocks, Firm Entry and Exit in a Heterogeneous Firm Model" I study the impact of oil price shocks on firm entry and exit. Using data on U.S. firm births and business failures I find that oil price shocks have a significant negative effect on firm entry and a positive effect on firm exit. This suggests that the extensive margin- the number of existing firms is an important mode of transmission for oil price shocks. I accordingly, build a DSGE model with heterogeneous firms which replicates this behavior of firm entry and exit and show that inclusion of firm entry and exit amplifies the effect of oil price shocks. Further, the DSGE model is able to explain selection patterns over the business cycle as the firms surviving after an oil price shock are bigger and more productive.