Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown

39 Pages Posted: 11 May 2021 Last revised: 18 Nov 2021

Date Written: September 18, 2019

Abstract

This paper analyses the procyclicality 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. 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 an increase in liquidity demand is identified as the most important driving force. The endogenous technology mechanism further exerts a dampening effect on the inflation response over the business cycle which helps rationalizing both the negligible fall in inflation during the Great Recession and the sluggish increase of inflation in the subsequent recovery.

Keywords: Endogenous Productivity, Euro Area Business Cycles, Weak Growth, Low Inflation

JEL Classification: E24, E32, O31

Suggested Citation

Elfsbacka Schmöller, Michaela and Spitzer, Martin, Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown (September 18, 2019). Bank of Finland Research Discussion Paper No. 21/2019, Available at SSRN: https://ssrn.com/abstract=3843530 or http://dx.doi.org/10.2139/ssrn.3843530

Michaela Elfsbacka Schmöller (Contact Author)

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

Martin Spitzer

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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