Technology Diffusion, Intertemporal Substitution, and Business Cycles

The recent literature on economic growth and business cycles, such as Helpman and Trajtenberg (1996), Hornstein and Krusell (1996), Jovanovic and Lack (1997), and Andolfatto and MacDonald (1998), shows that the diffusion of new technology is important in accounting for some features of aggregate fluctuations we observe in data. In some of the literature, one slowdown and subsequent recovery and growth (in productivity and output) are generated by one change in technology progress. This is because economic agents divert more resources to learning and adoption of new technology to implement new technology just after an innovation occurs. In this paper, we investigate the importance of technology diffusion in the framework of real business cycles in the view of intertemporal substitution behavior. The model is a standard real business cycle model, except that it assumes technology diffusion and variable labor effort. An innovation to technology diffuses over the economy with some time lag. This implies that an innovation in the present makes the near-future level of productivity higher than the present level as a result of technology diffusion. So intertemporal substitution behavior leads to a recessions in the present and subsequent expansion. Different types of the diffusion process can generate rich dynamics of aggregate variables, which includes business cycle asymmetries like ÏdeepnessÓ and Ïsteepness.Ó The former means that recessions are deeper than expansions are tall, and the latter that recessions are steeper than expansions. When we assume that some labor effort is necessary to adopt and learn about new technology, the above-mentioned intertemporal substitution is more powerful, and so a positive innovation to technology give rise to a severer recession before the subsequent expansion begins. This is because part of labor effort is diverted from production activity to learning activity during the process of technology diffusion. In addition we demonstrate that the process of diffusion and implementation is very important in accounting for business cycles. We find that a much smaller size of technology shocks can reproduce the realistic volatility of business cycles with diffusion than otherwise.