Empirical Analysis, indicating a negative tradeoff between long-run growth and economic stability appear sensitive with respect to policy intervention. I use a model of fully rational utility maximizing representative agents and profit maximizing firms acquiring rents by inventing a new product variety on which they have market power in a monopolistically competitive goods market. Monopolistic competition has been used in three contexts in modern economics: trade, growth and New Keynesianism. I shall use the latter two, together with a small menu cost argument enabling nominal price rigidity on the goods market, to show that monetary policy can stabilize the economy closer to potential output than laissez-faire in the short run, thereby inducing faster innovation driven endogenous growth in the long run. Whilst the effect of fiscal policy on growth and the effect of monetary policy on levels is not new to endogenous growth and New Keynesian models, respectively, the result of a growth effect of monetary policy, which the model describes, is genuine. Once again, this model is policy-oriented, analyzing the traditional instrument of monetary policy. The result indicates that monetary policy can achieve more than just driving the price level, but that there exist both short-run static and long-run dynamic real effects of monetary policy. Though it is not intended to send a clear political signal to central bankers, the sound theoretical framework of the analysis does allow to conclude that these effects indeed exist, but empirical tests are certainly necessary to detect the correctness of the theoretical conclusion.
|Name||Department of Economics Working Paper Series|
- Department of Economics Working Paper Series