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Monetary Policy, R&D and Economic Growth in an Open Economy

  • Chu, Angus C.

    ()

  • Cozzi, Guido

    ()

  • Lai, Ching-Chong
  • Liao, Chih-Hsing

This study analyzes the growth and welfare effects of monetary policy in a two-country Schumpeterian growth model with cash-in-advance constraints on consumption and R&D investment. We find that an increase in the domestic nominal interest rate decreases domestic R&D investment and the growth rate of domestic technology. Given that economic growth in a country depends on both domestic and foreign technologies, an increase in the foreign nominal interest rate also decreases economic growth in the domestic economy. When each government conducts its monetary policy unilaterally to maximize the welfare of only domestic households, the Nash-equilibrium nominal interest rates are generally higher than the optimal nominal interest rates chosen by cooperative governments who maximize the welfare of both domestic and foreign households. This difference is caused by a cross-country spillover effect of monetary policy arising from trade in intermediate goods. Under the CIA constraint on consumption (R&D investment), a larger market power of firms decreases (increases) the wedge between the Nash-equilibrium and optimal nominal interest rates. We also calibrate the two-country model to data in the Euro Area and the UK and find that the cross-country welfare effects of monetary policy are quantitatively significant.

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Paper provided by University of St. Gallen, School of Economics and Political Science in its series Economics Working Paper Series with number 1315.

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Length: 34 pages
Date of creation: Jun 2013
Date of revision:
Handle: RePEc:usg:econwp:2013:15
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