A primer on innovation and growth

Philippe Aghion emphasises that for Europe to stimulate innovation and growth, it is not enough to increase spending on research and development and the protection of intellectual property.

A corporate Balance-Sheet Approach to Currency Crises

The paper presents a general equilibrium currency crises model of the "third generation", in which the possibility of currency crises is driven by the interplay between private firms' credit-constraints and nominal price rigidities. Despite our emphasis on microfoundations, the model remains sufficiently simple that the policy analysis can be conducted graphically. The analysis hinges on two features: i) ex post deviations from purchasing power parity, ii) credit constraints a la Bernanke-Gertler, iii) foreign currency borrowing by domestic firms, iv) a competitive banking sector lending to firms and holding reserves and a monetary policy conducted either through open market operations or short-term lending facilities. We first show that with a positive likelihood of a currency crises, firms may indeed find it optimal to borrow in foreign currency, following Chamon (2001). Second, we derive sufficient conditions for the existence of sunspot equilibrium with currency crises. Third, we show that a reduction in the monetary base through restrictive open market operations is more likely to eliminate the poaaibility of currency crises if at the same time the central bank does not impose excessive constraints on short-term lending facilities.

Financial Liberalization and Volatility in Emerging Market Economies

The recent East Asian crisis has highlighted the relationship between financial development and output volatility. In this essay we develop a simple model of a small open economy producing a tradeable good using a non-tradeable input and where firms access to borrowings and investment depends on current cash flows. We then show, first that macroeconomic volatility only occurs at intermediate levels of financial development; second, that whilst full financial liberalization, including an unrestricted opening to foreign lending, can destabilize an emerging market economy, in contrast output volatility can be avoided if the same economy opens up to foreign direct investment only. We also draw several policy conclusions regarding the adequate responses to financial crises.emerging markets; volatility; financial liberalization

A Corporate Balance-Sheet Approach to Currency Crises

This paper presents a general equilibrium currency crisis model of the 'third generation', in which the possibility of currency crises is driven by the interplay between private firms' credit-constraints and nominal price rigidities. Despite our emphasis on microfoundations, the model remains sufficiently simple that the policy analysis can be conducted graphically. The analysis hinges on four main features: i) ex post deviations from purchasing power parity; ii) credit constraints a la Bernanke-Gertler; iii) foreign currency borrowing by domestic firms; iv) a competitive banking sector lending to firms and holding reserves and a monetary policy conducted either through open market operations or short-term lending facilities. We first show that with a positive likelihood of a currency crisis, firms may indeed find it optimal to borrow in foreign currency, following Chamon (2001). Second, we derive sufficient conditions for the existence of a sunspot equilibrium with currency crises. Third, we show that a reduction in the monetary base through restrictive open market operations is more likely to eliminate the possibility of currency crises if at the same time the central bank does not impose excessive constraints on short-term lending facilities.financial crisis; foreign currency debt; monetary policy

Financial Liberalization and Volatility in Emerging Market Economies

The recent East Asian crisis has highlighted the relationship between financial development and output volatility. In this essay we develop a simple model of a small open economy producing a tradeable good using a non-tradeable input and where firms access to borrowings and investment depends on current cash flows. We then show, first that macroeconomic volatility only occurs at intermediate levels of financial development; second, that whilst full financial liberalization, including an unrestricted opening to foreign lending, can destabilize an emerging market economy, in contrast output volatility can be avoided if the same economy opens up to foreign direct investment only. We also draw several policy conclusions regarding the adequate responses to financial crises.

A Model of Growth Through Creative Destruction

This paper develops a model based on Schumpeter's process of creative destruction. It departs from existing models of endogenous growth in emphasizing obsolescence of old technologies induced by the accumulation of knowledge and the resulting process or industrial innovations. This has both positive and normative implications for growth. In positive terms, the prospect of a high level of research in the future can deter research today by threatening the fruits of that research with rapid obsolescence. In normative terms, obsolescence creates a negative externality from innovations, and hence a tendency for laissez-faire economies to generate too many innovations, i.e too much growth. This "business-stealing" effect is partly compensated by the fact that innovations tend to be too small under laissez-faire. The model possesses a unique balanced growth equilibrium in which the log of GNP follows a random walk with drift. The size of the drift is the average growth rate of the economy and it is endogenous to the model ; in particular it depends on the size and likelihood of innovations resulting from research and also on the degree of market power available to an innovator.

No green growth without innovation. Bruegel Policy Brief 2009/07, November 2009

The 'green growth' debate is taking place in an oversimplified setting, largely disregarding the innovation factor. Technologies to mitigate climate change are being treated as given, or as emerging spontaneously, ignoring the fact that the portfolio of technologies available tomorrow depends on what is done today. This can easily lead to a misguided preference, either for subsidising the use of relatively inefficient technologies or for postponing action to later in the hope that new technologies will become available which will reduce the cost of fighting climate change. But the radical new emissions-free 'backstop technologies' we will need are not yet available, or else still far from the market. To foster their emergence the 'green innovation machine' must be turned on

Uncovering Some Causal Relationships between Productivity Growth and the Structure of Economic Fluctuations: A Tentative Survey

This paper discusses recent theoretical and empirical work on the interactions between growth and business cycles. One may distinguish two very different types of approaches to the problem of the influence of macroeconomic fluctuations on long-run growth. In the first type of approach, which relies on learning by doing mechanisms or aggregate demand externalities, productivity growth and direct production activities are complements. An expansion therefore has a positive long-run effect on total factor productivity. In the second type of approach, hereafter labeled 'opportunity cost or 'learning-by-doing', productivity growth and production activities are substitutes. The opportunity cost of some productivity improving activities falls in a recession, which has a long-run positive impact on output. This does not mean, however, that recessions should on average last longer or be more frequent, since the expectation of future recessions reduces today's incentives for productivity growth. We also briefly discuss some empirical work which is mildly supportive of the opportunity cost approach, while showing that it can be reconciled with the observed pro-cyclical behavior of measured total factor productivity. We also describe some theoretical work on the effects of growth on business cycles.