More on the Fed and Long-Term Growth

Michael Mandel

First, let me say that I just reviewed Ben Friedman’s new book, The Moral Consequences of Economic Growth. People should take a look.

Now onto Bernanke and what the Fed can do about growth:

In a comment to my previous post, pgl of Angry Bear writes:

Dr. Lingle is saying what Mark Thoma is saying - that the Federal Reserve can only influence real GDP in the short-run but cannot change either long-run output or output on average. In fact, most economists - Keynesian or classical - believe as such.
Right. Conventional macroeconomic theories have no role for macroeconomic policy affecting the underlying rate of technological change. In fact, the rate of technological change…which is what determines long term growth of per capita GDP…is completely outside the conventional model.

However, there are plenty of theories of so-called “endogenous” growth in which macro policy, or the capabilities of the financial system, can affect the rate of technological change.

Here’s one. Suppose that companies set their level of R&D spending as a percentage of sales (which in fact seems to be a typical rule of thumb). Also suppose that R&D spending permanently improves productivity.

It might make sense, then, to run the economy as hot as long as you can stand it, boosting sales and R&D spending, and getting productivity as high as you can. Then absorb a short nasty downturn to get the excesses out of the system, and then do it again.

Over the long run, that kind of stop and start behavior will give you faster growth than a smooth path—and it is something that the Fed can affect. That is, a central bank which tries to smooth out growth may end up discouraging welfare-enhancing R&D investments.

Three important notes here:

1.You know those old commercials, “I’m not a doctor but I play one on TV.” In my case, I am an economist by training (PhD, Harvard, same entering class as Glenn Hubbard). But I don’t do regressions and I don’t write down equations and mathematical models. These days, I work with words and concepts that anyone can understand.

2.However, plenty of professional economists have written down models where booms and busts can be welfare-improving. For example, see the paper, "Speculative Growth: Hints from the US Economy" by Ricardo Caballero, Emmanuel Farhi and Mohamad L. Hammour http://www.nber.org/papers/w10518.

3.I’m frankly tired of economists quoting conventional macro models at me, when it’s clear that all the action in recent years has been on the technology side. Get with the 21st century, guys.

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