Volatility costs of R&D

Abstract

This paper incorporates endogenous growth into a New Keynesian DSGE framework to investigate the effects of R&D on economic volatility. It identifies a mechanism through which the cyclicality of R&D and its effects on volatility depend on the cyclicality of production. R&D activity becomes more procyclical, thereby amplifying economic volatility when labor is procyclical. The conclusions are reversed if labor is countercyclical. Alternative calibrations show that this link between R&D and production labor is weaker when R&D intensity, the spillover rate of innovation, and R&D adjustment costs are higher. In these cases, R&D tracks economic activity more closely which in turn magnifies economic volatility. The higher volatility has considerable welfare consequences and it implies that the steeper path of growth resulting from higher R&D activity comes at a price.