Endogenous Technological Change and the New Keynesian Model

This paper develops and estimates a new Keynesian (NK) model with endogenous technology. It shows that introducing endogenous technology can solve three important puzzles faced by conventional NK models: the “inflation persistence”, “disinflationary news shock”, and “zero lower bound (ZLB) supply shock” puzzles. First, the observed persistence in inflation is explained without relying on the conventional NK models' additional assumptions, e.g., backward price indexation. Second, it explains the observed disinflationary effect of a news shock. Third, the model avoids the conventional NK models' paradoxical, empirically inconsistent prediction that a negative supply shock is expansionary at the ZLB on interest rates.

Convergence and Divergence under Global Trade

We construct a model of endogenous technological change with trade (in the absence of foreign direct investment separating innovation from production) that displays multiple steady states with divergence in levels and in growth rates. This shows trade can be a force for both development and underdevelopment. Our dynamic model of trade simultaneously explains: comparative advantage, the advantages of being open for the technological leader, that lagging countries might benefit from being closed, the possibility of divergence under trade for lagging countries, and under what circumstances lagging countries can converge to development under trade, possibly overtaking the leader. The sources of divergence we consider are inherent characteristics of the process of technological change (for example as described throughout Aghion and Howitt’s work). The first is the need for absorptive capacity for innovators taking advantage of leading edge technologies. The second is the existence of innovation externalities between goods, the basis of technology spillovers and of the concept of “leading edge technology.” It follows that the more goods are engaged in R&D in any country, the more productive R&D is. We provide a historical discussion of the emergence of development and underdevelopment during the 19th Century and until 1914 that is consistent with and exemplifies the possibilities explained by the model.