Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown in the Euro Area

38 Pages Posted: 7 May 2020

Date Written: May, 2020


This paper analyses the endogeneity of euro area total factor productivity and its role in business cycle amplification by estimating a medium-scale DSGE model with endogenous productivity mechanism on euro area data. In this framework, total factor productivity evolves endogenously as a consequence of costly investment in R&D and adoption of new technologies. We find that the endogeneity of TFP induces a high degree of persistence in the euro area business cycle via a feedback mechanism between overall economic conditions and investment in productivity-enhancing technologies. As to the sources of the euro area productivity slowdown, we conclude that a decrease in the efficiency of R&D investment is among the key factors generating the pre-crisis productivity slowdown, while starting from the Great Recession a shock to liquidity demand is identified as the most important driving force. The endogenous technology mechanism further exerts a dampening effect on the inflation response following a recessionary shock and hence has important implications for both the negligible fall in inflation during the Great Recession, as well as the sluggish increase of inflation in the subsequent recovery.

Keywords: endogenous productivity, euro area business cycles, low inflation, weak growth

JEL Classification: E24, E32, O31

Suggested Citation

Spitzer, Martin and Elfsbacka Schmöller, Michaela, Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown in the Euro Area (May, 2020). ECB Working Paper No. 20202401, Available at SSRN: https://ssrn.com/abstract=3595231 or http://dx.doi.org/10.2139/ssrn.3595231

Martin Spitzer (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

Michaela Elfsbacka Schmöller

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101

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