Lumpy R&D and the Great Twins: Great Moderation and Great Recession
70 Pages Posted: 8 May 2024
Date Written: May 6, 2024
Abstract
We document that firm-level R&D investments are lumpy, characterized by episodes of inaction and large increases in R&D expenses. Furthermore, the share of firms making spike adjustments in their R&D expenses is pro-cyclical and explains 75% of the pro-cyclicality of aggregate R&D. Motivated by these empirical findings, we develop a medium-run business cycle model with heterogeneous innovative firms and fixed adjustment costs, featuring lumpy R&D. Within this framework, we identify a novel mechanism that gives rise to the ‘Great Twins’ hypothesis: the Great Moderation—characterized by reduced economic fluctuations until 2008—caused the observed severity of the subsequent Great Recession. We provide micro- and macro-level evidence supporting this hypothesis. Finally, we discuss the policy implications of our findings, including the novel tail-risk and variance tradeoff faced by central banks.
Keywords: Heterogeneous Innovators, Lumpy R&D, Distribution, Great Twins, Medium-run Business Cycles
JEL Classification: E32, O31, O33
Suggested Citation: Suggested Citation