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Lower for longer under endogenous technology growth

Michaela Elfsbacka Schmöller and Martin Spitzer

No 2714, Working Paper Series from European Central Bank

Abstract: This paper studies monetary policy strategies under endogenous technology dynamics and low r*. Endogenous growth strengthens the gains from make-up strategies relative to inflation targeting, especially if policy space is reduced. This result is due to the long-run non-neutrality of money and the hysteresis effects in TFP through which ELB episodes generate permanent scars on long-run aggregate supply. Make-up strategies not only foster the alignment of inflation with target but also support productivity-improving investment in R&D and technology adoption and hence the long-run trend path, provided that the inherent make-up element is sufficiently pronounced. Inflation is less responsive to monetary policy due to the interaction with productivity dynamics. As a result, additional stimulus is required at the ELB and the degree of subsequent overshooting is alleviated. Endogenous growth also generates novel monetary policy trade-offs, most notably credibility challenges, which can be mitigated by confining make-up elements to ELB episodes. JEL Classification: E24, E31, E32, E52, O30

Keywords: cycle-trend interaction; endogenous TFP; hysteresis; make-up strategies; ZLB (search for similar items in EconPapers)
Date: 2022-08
New Economics Papers: this item is included in nep-dge and nep-gro
Note: 626509
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