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We study how firm heterogeneity and market power affect macroeconomicfragility, defined as the probability of long slumps. We propose a theory inwhich the positive interaction between firm entry, competition and factorsupply can give rise to multiple steady-states. We show that when firmheterogeneity is large, even small temporary shocks can trigger firm exit andmake the economy spiral in a competition-driven poverty trap. We calibrate ourmodel to incorporate the well-documented trends on rising firm heterogeneity inthe US economy, we show that they significantly increase the likelihood andlength of slow recoveries. We use our framework to study the 2008-09 recessionand show that the model can rationalize the persistent deviation of output andmost macroeconomic aggregates from trend, including the behavior of net entry,markups and the labor share. Post-crisis cross-industry data corroborates ourproposed mechanism. We conclude by showing that firm subsidies can be powerfulin preventing long slumps and can lead to up to a 21% increase in welfare.

Firm Heterogeneity, Market Power and Macroeconomic Fragility