Periodic Reporting for period 2 - KEYNESGROWTH (Economic Fluctuations, Productivity Growth and Stabilization Policies: A Keynesian Growth Perspective)
Reporting period: 2021-07-01 to 2022-12-31
The modern macroeconomic literature separates the study of business cycles from the analysis of long-run productivity growth. Yet, the interactions between economic fluctuations, productivity growth and stabilization policies are well present in the policy debate. The objective of this project is to develop a Keynesian growth framework to study business cycles, productivity growth and macroeconomic policies in a unified theory. The framework combines the Keynesian insight that fluctuations might be driven by changes in aggregate demand, with the notion, developed by the endogenous growth literature, that productivity growth is the result of firms’ investment in innovation.
Among other applications, the project aims to shed light on the productivity growth slowdown characterizing several advanced economies since the Great Recession, the pattern of productivity growth experienced by euro area countries since the inception of the common currency, the impact of capital flows from developing countries to the United States on global productivity, as well as the effect of the Covid-19 pandemic and the subsequent recovery on global growth. These are first order macroeconomic questions, around which lively policy debates have developed.
Among other applications, the project aims to shed light on the productivity growth slowdown characterizing several advanced economies since the Great Recession, the pattern of productivity growth experienced by euro area countries since the inception of the common currency, the impact of capital flows from developing countries to the United States on global productivity, as well as the effect of the Covid-19 pandemic and the subsequent recovery on global growth. These are first order macroeconomic questions, around which lively policy debates have developed.
So far, the project has resulted in several articles, which have been published in leading academic journals, presented widely to academic and policy audiences, and cited by the general audience press. These articles, briefly summarized below, employ a Keynesian growth approach to revisit some of the most prominent current macroeconomic debates.
What is the impact of adopting a common currency on capital flows and productivity? The paper “A Theory of Monetary Union and Financial Integration” (Review of Economic Studies, 2022) tackles this question by providing a novel framework connecting monetary policy, capital flows and productivity growth. It shows that forming a currency union leads to higher capital mobility, by eliminating exchange rate risk. High capital mobility, however, may give rise to episodes of disorderly capital flights, associated with capital misallocation and productivity losses. The paper thus offers a novel perspective on the experience of the euro, characterized by large and volatile capital flows among member countries, and on the policy interventions that can reconcile free capital mobility and healthy growth in monetary unions.
While much has been written about the global saving glut – i.e. the large flows of capital running from developing countries to the United States – its impact on global growth is still poorly understood. To tackle this issue, the paper “The Global Financial Resource Curse”, joint with Gianluca Benigno and Martin Wolf, develops a novel framework connecting capital flows and productivity. It shows that capital inflows may harm productivity growth in the United States, by reducing the competitiveness of U.S. firms and their investment in innovation. This insight runs against the conventional view stating that capital inflows foster growth by facilitating investments. Moreover, the model suggests that the U.S. productivity growth slowdown may negatively affect developing countries, since part of their productivity growth depends on technology imports from the United States. Through this channel, the global saving glut may depress global growth. The model is useful to think about the impact of different policy interventions - such as reserve accumulation by developing countries, or innovation policies in the United States – on global growth.
The paper “Monetary Policy in the Age of Automation”, joint with Martin Wolf, provides a framework connecting monetary policy and firms’ adoption of automation technologies, a topic previously unexplored by the monetary economics literature. The model highlights the presence of an automation effect of monetary policy: a monetary easing, by lowering the cost of capital, may induce firms to adopt more capital-intensive technologies. One interesting implication of this effect is that the economy features multiple long-run equilibria consistent with full employment, each associated with different degrees of automation and productivity. Monetary interventions may move the economy across different long-run equilibria, and a temporary monetary policy expansion may permanently increase firms’ use of automation technologies, labor productivity and real wages.
What is the effect of a large negative supply shock, for instance caused by a pandemic, on growth and inflation? The article “The Scars of Supply Shocks”, joint with Martin Wolf, addresses this question with the help of the Keynesian growth framework. The paper shows that, contrary to conventional wisdom, a large supply disruption may decrease inflation. The reason is that large negative supply shocks, by depressing firms’ investment, result in persistent drops in output. The associated negative wealth effect lowers demand and inflation. A companion short paper, titled “Covid-19 Coronavirus and Macroeconomic Policy”, revisits the impact of the Covid-19 shock through the lens of the Keynesian growth framework.
The recovery from the Covid-19 recession has been characterized by a global rise in inflation. The paper “Monetary Policy during Unbalanced Global Recoveries”, joint with Federica Romei, provides a framework useful to understand why this has been the case. The paper shows that the reallocation of expenditure from services to goods that has characterized the pandemic may push the global economy into stagflation. The reason is that inflation is needed to facilitate the sectoral reallocation of production, and to mitigate the impact of the shock on employment. The paper also shows how inflation gets transmitted across countries, and discusses the risk that national monetary authorities may engage in perverse reverse currency wars.
What is the impact of adopting a common currency on capital flows and productivity? The paper “A Theory of Monetary Union and Financial Integration” (Review of Economic Studies, 2022) tackles this question by providing a novel framework connecting monetary policy, capital flows and productivity growth. It shows that forming a currency union leads to higher capital mobility, by eliminating exchange rate risk. High capital mobility, however, may give rise to episodes of disorderly capital flights, associated with capital misallocation and productivity losses. The paper thus offers a novel perspective on the experience of the euro, characterized by large and volatile capital flows among member countries, and on the policy interventions that can reconcile free capital mobility and healthy growth in monetary unions.
While much has been written about the global saving glut – i.e. the large flows of capital running from developing countries to the United States – its impact on global growth is still poorly understood. To tackle this issue, the paper “The Global Financial Resource Curse”, joint with Gianluca Benigno and Martin Wolf, develops a novel framework connecting capital flows and productivity. It shows that capital inflows may harm productivity growth in the United States, by reducing the competitiveness of U.S. firms and their investment in innovation. This insight runs against the conventional view stating that capital inflows foster growth by facilitating investments. Moreover, the model suggests that the U.S. productivity growth slowdown may negatively affect developing countries, since part of their productivity growth depends on technology imports from the United States. Through this channel, the global saving glut may depress global growth. The model is useful to think about the impact of different policy interventions - such as reserve accumulation by developing countries, or innovation policies in the United States – on global growth.
The paper “Monetary Policy in the Age of Automation”, joint with Martin Wolf, provides a framework connecting monetary policy and firms’ adoption of automation technologies, a topic previously unexplored by the monetary economics literature. The model highlights the presence of an automation effect of monetary policy: a monetary easing, by lowering the cost of capital, may induce firms to adopt more capital-intensive technologies. One interesting implication of this effect is that the economy features multiple long-run equilibria consistent with full employment, each associated with different degrees of automation and productivity. Monetary interventions may move the economy across different long-run equilibria, and a temporary monetary policy expansion may permanently increase firms’ use of automation technologies, labor productivity and real wages.
What is the effect of a large negative supply shock, for instance caused by a pandemic, on growth and inflation? The article “The Scars of Supply Shocks”, joint with Martin Wolf, addresses this question with the help of the Keynesian growth framework. The paper shows that, contrary to conventional wisdom, a large supply disruption may decrease inflation. The reason is that large negative supply shocks, by depressing firms’ investment, result in persistent drops in output. The associated negative wealth effect lowers demand and inflation. A companion short paper, titled “Covid-19 Coronavirus and Macroeconomic Policy”, revisits the impact of the Covid-19 shock through the lens of the Keynesian growth framework.
The recovery from the Covid-19 recession has been characterized by a global rise in inflation. The paper “Monetary Policy during Unbalanced Global Recoveries”, joint with Federica Romei, provides a framework useful to understand why this has been the case. The paper shows that the reallocation of expenditure from services to goods that has characterized the pandemic may push the global economy into stagflation. The reason is that inflation is needed to facilitate the sectoral reallocation of production, and to mitigate the impact of the shock on employment. The paper also shows how inflation gets transmitted across countries, and discusses the risk that national monetary authorities may engage in perverse reverse currency wars.
The Keynesian growth approach to macroeconomic policy represents a significant breakthrough with respect to the existing literature, and in particular with respect to the New Keynesian model that currently dominates the monetary policy debate. The Keynesian growth framework, in fact, opens up new possibilities to study the interactions between demand factors and productivity growth, a topic relatively unexplored by the existing literature.
The remaining part of the project will keep on developing the Keynesian growth framework, and applying its insights to understand important macroeconomic phenomena. Aside from continuing on working on the papers mentioned above, there are at least two areas in which I plan to make progress.
First, I plan to explore the quantitative properties of some of the frameworks introduced during the first phase of the project. This will help other researchers, especially in policy institutions, to use these frameworks in their policy evaluation exercises. Second, I plan to further explore which kind of policy interventions can reconcile high capital mobility and healthy growth in monetary unions. This line of research will contribute to the current debate on the future of the European Central Bank.
The remaining part of the project will keep on developing the Keynesian growth framework, and applying its insights to understand important macroeconomic phenomena. Aside from continuing on working on the papers mentioned above, there are at least two areas in which I plan to make progress.
First, I plan to explore the quantitative properties of some of the frameworks introduced during the first phase of the project. This will help other researchers, especially in policy institutions, to use these frameworks in their policy evaluation exercises. Second, I plan to further explore which kind of policy interventions can reconcile high capital mobility and healthy growth in monetary unions. This line of research will contribute to the current debate on the future of the European Central Bank.