How to reverse a negative asymmetric labor productivity shock in the European Union? A directed technical change analysis with fiscal and monetary policies

Abstract

We developed a directed technical change growth model with two stylized (European) countries. Although Covid19 had several economic implications, it caused a negative asymmetric shock in EU member states’ labor productivity, which is slightly stronger in the impoverished South. This instrumental option arose from the need to isolate this effect from all others. The shock causes an immediate fall in the Union’s growth rate and inflation rate. The fiscal policy, driven by the country’s governments and materialized through direct and indirect subsidies to R&D activity, reinforces its production, technological knowledge, and wage level. The effects are stronger when conducted by North/Germany. The monetary policy, led by the central bank through a decline in the nominal interest rate, influences the R&D activity through Cash-in-Advance constraints and is limited by the zero nominal interest rate. The inflation rate is positively affected by monetary-transaction costs and the way money influences the utility function.