Productivity slowdown and monetary policy

Mewael F. Tesfaselassie

No 57, Kiel Policy Brief from Kiel Institute for the World Economy (IfW Kiel)

Abstract: In the aftermath of the financial crisis of 2007 - 2008 (and the resulting Great Recession) policymakers became concerned about a potential long-term effect of the crisis on the wider economy. For instance, in an ECFIN Economic Brief titled The financial crisis and potential growth: Policy challenges for Europe, Jan Koopman and Székely (2009) remark that a potential casualty of the financial crisis involves permanently lower potential growth rate of GDP. Similarly, in an OECD working paper, The Macroeconomic Consequences of Banking Crises in OECD Countries Haugh et al. (2009) point out that the protracted banking crisis in Japan in the 1990s may have been responsible for the reduction in the country's long-term (or trend) potential growth. This policy paper discusses the consequence of changes in potential growth for monetary policy performance and design. The discussion focuses on how the nature of the so-called Phillips curve, which is the hallmark of monetary policy, changes with changes in potential growth and what this means for designing monetary policy. It puts the discussion in historical perspectives, namely, the Great Inflation of the 1970s and the New Economy of the 1990s, as these episodes were characterized by changes in long-term productivity growth. The Great Inflation of the 1970s was accompanied by trend productivity slowdown while the New Economy of the 1990s was characterized by trend productivity pickup, which was driven by innovations in information technology. Both the Great Inflation and the New Economy are interesting episodes, as both also involved academic and policy debates as to the role of monetary policy in limiting or accentuating the effects of productivity growth.

Date: 2012
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