The Keynesian Growth Approach to Macroeconomic Policy and Productivity   Liberty Street Economics
Liberty Street Economics

« Expecting the Unexpected: Job Losses and Household Spending | Main | Are New Repo Participants Gaining Ground? »

April 01, 2019

The Keynesian Growth Approach to Macroeconomic Policy and Productivity



The Keynesian Growth Approach to Macroeconomic Policy and Productivity

Productivity is one of the key determinants of potential output—that is, the trend level of production consistent with stable inflation. A productivity growth slowdown has occurred in several advanced economies in the aftermath of the global financial crisis, raising concerns about long-term growth. In response, a variety of supply-side policy options have been proposed, such as reforms to increase labor and product market flexibility. In this blog post, we consider the role of demand-side policies in raising trend productivity growth.

Supply and Demand Drivers of Productivity
The chart below illustrates the decline in labor productivity growth in the United States, the euro area, and the United Kingdom since the global financial crisis.

The Keynesian Growth Approach to Macroeconomic Policy and Productivity


A view deeply entrenched in mainstream macroeconomics is that trend productivity growth is the outcome of technological and institutional factors and can be treated essentially as an exogenous force, unresponsive to business cycles or monetary policy actions. The workhorse macroeconomic models used by international organizations and central banks are built upon this notion.

This view, however, struggles to explain some key empirical facts. For instance, Blanchard et al. (2015) show that recessions tend to be followed by prolonged slowdowns in productivity growth, causing persistent deviations of output from prerecession trends. This evidence suggests that recessions have an impact on long-run output, a phenomenon known as hysteresis. In a similar vein, Ball (2014) has emphasized how the Great Recession has been associated with permanent drops in the trend path of output in most advanced economies.

The Keynesian Growth Approach to Macroeconomic Policy and Productivity


These facts, as pointed out by several economists (Fatas and Summers, Kocherlakota, Krugman, Smith, Wren-Lewis), suggest that the conventional wisdom might be incomplete and that trend productivity responds to changes in aggregate demand. In turn, this suggests that traditional views on the link between monetary policy and long-term growth need to be re-evaluated.

The Keynesian Growth Framework
In Benigno and Fornaro (2018), we propose an approach that we call “Keynesian Growth,” in which the demand and supply sides of the economy are intrinsically linked, so that cyclical fluctuations and long-term trends are interdependent. By providing a theory of long-run growth that builds upon a Keynesian approach to economic fluctuations, our approach brings together the Keynesian insight that falling demand causes recessions with the notion, developed in the endogenous growth literature, that productivity growth is the result of investment in innovation and new technologies by profit-maximizing firms. Thus, departing from the neoclassical framework, in which productivity is determined by exogenous forces, our approach treats productivity growth as an endogenous phenomenon.

In this framework, aggregate demand is one of the key determinants of business investment spending and productivity growth. For example, companies have little appetite for investing in new technologies during a recession, because they anticipate that the profits derived from this investment will be low. As a result, future productivity growth falls and the economy’s potential output drops. Through this channel, temporary recessions can have persistent adverse consequences for long-run output.

At the same time, low future growth prospects can depress current demand. For instance, a slowdown in the growth rate of labor productivity lowers households’ expected future income and thereby restrains current consumption.

Our model thus suggests that healthy productivity growth is tied to the resiliency of the economy to business cycle shocks. Effective aggregate demand management yields long-term economic benefits by spurring business investment, which then supports current demand, creating a positive feedback loop.

Policy Implications
As a corollary, our model also suggests that counter-cyclical monetary policy can play a key role in supporting trend productivity growth. Three aspects of this relationship are worth emphasizing.

  • First, in the Keynesian Growth framework, monetary policy expansions support investment spending and capital deepening by lowering the cost of credit and increasing the profitability of investing in future productive capacity. Empirical evidence presented by Aghion et al. (2018) and Moran and Queralto (2018) indicates that monetary policy expansions lead to higher investment in innovation and productivity growth.
  • Second, productivity growth should be considered part of the tradeoff that monetary authorities face. As a thought experiment, consider the case in which an economy enjoys near full employment and price stability while struggling with low productivity growth. In our model, deviations of the monetary stance from neutral would facilitate higher future productivity.
  • The third aspect concerns the limits to monetary policy. Monetary policy cannot always provide the necessary stimulus to stabilize the economy during a recession—for instance, because of the zero lower bound on interest rates. In such cases, our Keynesian Growth framework acknowledges that constraints on monetary policy incur long-term costs, which stem from a lower trajectory for trend productivity growth. In this context, the social losses from insufficient accommodation in the short term may get amplified by a long-term fall in potential output stemming from a lack of productivity-boosting investment spending.


Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.




Gianluca BenignoGianluca Benigno is an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.


Luca Fornaro is a junior researcher at CREI and research professor at the Barcelona Graduate School of Economics.


How to cite this blog post:
Gianluca Benigno and Luca Fornaro, “The Keynesian Growth Approach to Macroeconomic Policy and Productivity,” Federal Reserve Bank of New York Liberty Street Economics (blog), April 1, 2019, https://libertystreeteconomics.newyorkfed.org/2019/04/the-keynesian-growth-approach-to-macroeconomic-policy-and-productivity.html.
Posted by Blog Author at 07:00:00 AM in Macroecon
Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Thomas:

Thanks for your comment. We are indeed working on a review article that will discuss these links with the post-Keynesian literature.

Thank you for an important post that "rethinks" macroeconomics. However, it is interesting to note that the idea that demand affects trend productivity is really "rediscovery" of an hypothesis that has been de rigeur among post-Keynesians in the tradition of Kaldor for around fifty years, sometimes called the Kaldor-Verdoorn Law.

Verify your Comment

Previewing your Comment

This is only a preview. Your comment has not yet been posted.

Working...
Your comment could not be posted. Error type:
Your comment has been saved. Comments are moderated and will not appear until approved by the author. Post another comment

The letters and numbers you entered did not match the image. Please try again.

As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.

Having trouble reading this image? View an alternate.

Working...

Post a comment

About the Blog
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.

The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.

The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.


Economic Research Tracker

Liberty Street Economics is now available on the iPhone® and iPad® and can be customized by economic research topic or economist.


Most Viewed

Last 12 Months
Useful Links
Comment Guidelines
We encourage your comments and queries on our posts and will publish them (below the post) subject to the following guidelines:
Please be brief: Comments are limited to 1500 characters.
Please be quick: Comments submitted after COB on Friday will not be published until Monday morning.
Please be aware: Comments submitted shortly before or during the FOMC blackout may not be published until after the blackout.
Please be on-topic and patient: Comments are moderated and will not appear until they have been reviewed to ensure that they are substantive and clearly related to the topic of the post. We reserve the right not to post any comment, and will not post comments that are abusive, harassing, obscene, or commercial in nature. No notice will be given regarding whether a submission will or will not be posted.‎
Disclosure Policy
The LSE editors ask authors submitting a post to the blog to confirm that they have no conflicts of interest as defined by the American Economic Association in its Disclosure Policy. If an author has sources of financial support or other interests that could be perceived as influencing the research presented in the post, we disclose that fact in a statement prepared by the author and appended to the author information at the end of the post. If the author has no such interests to disclose, no statement is provided. Note, however, that we do indicate in all cases if a data vendor or other party has a right to review a post.
Archives