Technology creation, business cycles and monetary transmission

In this paper, we take a path less travelled and investigate the effects of technology creation on business cycles rather than the other way around. We build and embed an endogenous growth mechanism into an otherwise standard New Keynesian DSGE model and show that R&D activity amplifies the output responses to systematic shocks. This relationship is generated by the R&D smoothing behavior of monopolistically competitive firms whose output responsiveness to shocks, such as monetary policy shocks, is proportional to their R&D intensity. An empirical investigation that uses firm-level data and focuses on monetary policy produces results that are consistent with the predictions of our model. Specifically, we find that monetary policy transmission operates primarily through R&D intensive firms. The more general and unique inference that we draw from our analyses is that the standard negative link between short-term volatility and long-term economic growth could be reversed if R&D is the source of economic growth. Specifically, R&D-driven innovation, an unequivocally growth enhancing activity, can at the same time introduce higher short-term output responsiveness.