Monetary Policy in a Schumpeterian Growth Model with Vertical R&D Sectors

Abstract

We explore the growth and welfare effects of monetary policy in a Schumpeterian economy with cash-in-advance (CIA) constrained R&D investment in both the upstream and downstream sectors. We show that the nominal interest rate can have an inverted-U relation with economic growth due to its effects on labor allocations between manufacturing and R&D and between the R&D sectors. Furthermore, aggregate R&D overinvestment is generally sufficient but not necessary for the Friedman rule of zero nominal interest rates to be suboptimal. Calibrated using data from US manufacturing firms, our model features a positive welfare-maximizing nominal interest rate despite aggregate R&D underinvestment.

Keywords: Monetary policy; Zero interest rate; Endogenous growth; R&D; Creative destruction

JEL Classification: O30, O40, E41