Endogenous growth and wave-like business fluctuations

• Authors: Mauro Bambi, Fausto Gozzi and Omar Licandro
• Journal of Economic Theory, Vol. 154, 68-111, August 2017

This paper argues that observed long lags in innovation implementation rationalize Schumpeter's statement that “wave-like fluctuations in business … are the form economic development takes in the era of capitalism.” Adding implementation delays to an otherwise standard endogenous growth model with expanding product variety, the equilibrium path admits a Hopf bifurcation where consumption, R&D and output permanently fluctuate. This mechanism is quantitatively consistent with the observed medium-term movements of US aggregate output. In this framework, an optimal allocation may be restored at equilibrium by the mean of a procyclical subsidy, needed to generate additional consumption smoothing. Finally, a procyclical R&D subsidy rate designed to half consumption fluctuations will increase the growth rate from 2.4% to 3.4% with a 9.6% (compensation equivalent) increase in welfare.