Published online by Cambridge University Press: 10 September 2019
This paper examines how innovation-led growth affects optimal monetary policy. We consider the Ramsey policy in a New Keynesian model where R&D leads to an expanding variety of intermediate goods and compare the results with those obtained when the expansion occurs exogenously. Positive trend inflation is found to be optimal under both assumptions, but much higher with profit-seeking innovation. Optimal monetary policy must be counter-cyclical in response to both technology and public spending shocks, yet the intensity of the reaction crucially depends on the presence of an R&D sector. However, the small amount of short-run deviations of prices from the non-zero trend inflation observed in response to shocks suggests inflation targeting as a robust policy recommendation.
We are very grateful to an anonymous referee for excellent comments and suggestions. We have also benefited from presentations at the DEGIT XXI Conference - University of Nottingham, the 4th Macro Banking and Finance Workshop - Sapienza University of Rome, the 2nd FGN International Conference - University of Saint Gallen, the Workshop on Economic Growth, Innovation, and Corporate Governance - SKEMA Business School, the 13th Biennial Athenian Policy Forum Conference Program and the conference on Finance and Economic Growth in the Aftermath of the Crisis - University of Milan.
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