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Long-Run Growth and Business Cycle Volatility

Claudio Michelacci ()

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: Before implementation, a new idea is a private good as it is both rivalrous and excludable. Its widespread economic consequences arise only when a researcher finds the market resources that suit its economic applicability. In this context we analyse how an increase in the size of business fluctuations (business cycle volatility) affects the growth process. In a Keynesian world in which different agents interact in the market, the business cycle affects growth through two margins: the incentive to do research and implement ideas and the amount of resources available in the economy. In this paper we show how the business cycle creates disequilibrium and imbalances in the economy. In fact, it destroys the possible good balance between the amount of resources available and the incentive to use them, raising the former and reducing the latter in recession and vice-versa during the boom. As both margins are strictly required to innovate, an economy with high levels of business cycle volatility will not be able to innovate much. This and other implications of the model seem to broadly match both recent theoretical and empirical evidence.

Date: 1997-07
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