Transitory Productivity Shocks and Long-Run Output

This paper analyzes the effects of transitory productivity shocks on long-run output. The study demonstrates that, despite it transitory nature, an adverse productivity shock may result in lower long-run output. A fall in productivity reduces output and savings and, consequently, the interest rate increases and investment in human capital falls. Although productivity returns to its initial level, a sufficiently large reduction in investment pushes the economy to a new stationary equilibrium with lower output. A redistribution of income from consumers to savers may restore the initial long-run output. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.