Abstract
Problem statement: Recent neoclassical theoretical study, particularly in the endogenous growth literature, has studied the nature of the relationship between economic growth and product quality. However, little attention has been given to the impact of a rise in product quality on effective demand under stagnation. This is because previous models have assumed that demand is always met with supply in labor and products markets. Therefore, the question remains as to whether a rise in product quality increases effective demand when stagnation occurs. Approach: This study applied an idea of stagnation and combined it with a quality ladder model to account for the relationship between product quality and effective demand under stagnation. Using this extended framework, this study examined the impact on effective demand of an R and D subsidy that improved product quality when stagnation occurs. Results: The results indicated that a rise in product quality increased the efficiency of consumption utility function and thereby enabled people to enjoy higher utility while consuming the same amount. However, under stagnation, people chose not to increase their utility, causing realized consumption to decrease and saving to increase. Consequently, effective demand decreased and the stagnation worsened. Conclusion: From the results, it can be concluded that use of R and D subsidies that improves product quality is not appropriate for a country where stagnation occurs.
Highlights
The Japanese economy has been facing persistent stagnation since the stock market bubble collapsed in 1990
We investigate whether Information Technology (IT) investment-enhancing policy improves or worsens aggregate economic activity under stagnation, using a dynamic optimization model
We consider the effects on effective demand of an unanticipated increase in an R and D subsidy that leads to an increase of product quality, under stagnation
Summary
The Japanese economy has been facing persistent stagnation since the stock market bubble collapsed in 1990. The question remains as to whether a rise in product quality increases effective demand when stagnation occurs. “Keynes’s rule” in the steady state, that ρ + πp = R = v′(m)/u′(c), where ρ + πp is the nominal rate of time preference, πp is the instant rate of inflation, R is the return to equities and v′(m)/u′(c) is the liquidity premium.
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