Schumpeterian Growth, Price Rigidities, and the Business Cycles

Embedding Schumpeterian innovation within a New Keynesian DSGE model matters for the likelihood of innovating when making endogenous decisions about investments in R&D and the path of the technological frontier. This feature brings new challenges at the modeling and simulation stages with implications for the interactions between Schumpeterian innovation and price rigidities, and between business cycle and growth. The interplay of innovation with optimal price setting in the intermediate sector spells out how the technological frontier advances, and how more innovation leads to more price flexibility despite the existence of nominal rigidities. With a reasonable calibration, key moments and comovements of macroeconomic variables are consistent with their observed counterparts. The Schumpeterian features of the model play a role on the cyclical impacts of various standard shocks and that of a knowledge-spillover shock. Moreover, different combinations of steady-state innovation probability and extent of knowledge spillovers, for the same steady-state growth rate of the economy, have important welfare implications in consumption equivalent terms.