The Persistence of Low Growth and Low Inflation in a New Keynesian Model with Human Capital-based Endogenous Growth
Final Report Abstract
▪ Our analysis shows that a model with endogenous human capital accumulation and skill loss from long-term unemployment can account for key features of the Great Recession: (i) the "productivity puzzle", the permanent gap between productivity (and output) relative to precrisis trends, and (ii) the "missing disinflation puzzle", the relative stability of inflation despite a pronounced fall in output In the model, lower aggregate demand raises unemployment and the training costs associated with skill obsolescence. ▪ Our analysis shows that the introduction of the training cost channel is key in the amplification of the fall in output growth, the rise in unemployment and the stability of in inflation while the endogenous growth channel is responsible for output hysteresis. Moreover, the hysteresis effect of endogenous growth is larger in the presence of training costs than in the absence of training costs, thereby suggesting complementarity between the two channels. ▪ Our analysis shows that, two key features of our model—endogenous growth through learningby-doing externality in human capital accumulation as well as training costs associated with skill loss from long-term unemployment—lead to potential inefficiency of the competitive economy. Optimal monetary policy faces a tradeoff when attempting to stabilize the economy in response to aggregate shocks. A policy that follows a traditional Taylor rule is sub-optimal, implying too much volatility in inflation but too little volatility in output and unemployment. ▪ Our analysis shows that, two key features of our model—endogenous growth through learningby-doing externality in human capital accumulation as well as training costs associated with skill loss from long-term unemployment—complement each other to generate output and unemployment multipliers that are substantially larger than in standard models. These results hold for alternative forms of fiscal financing (lump-sum tax, distortionary tax and government debt) as well as alternative labor market institutions (US and Europe). Our results suggest that fiscal stimulus is crucial for supporting economic activity, maintaining human capital and thereby avoiding the permanent scars from deep recessions.
Publications
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Endogenous Growth, Skill Obsolescence and Optimal Monetary Policy. SSRN Electronic Journal.
Tesfaselassie, Mewael & Lechthaler, Wolfgang
