What Happens When the Productivity Growth Trend Changes?

Recent evidence of an increase in the trend rate of productivity growth inspires speculation about how a change in the underlying process of technological progress might be associated with adjustment dynamics. This paper considers such dynamics in the framework of a computable general equilibrium model that incorporates stochastic growth. Simulations of the model suggest that transition dynamics between steady state growth paths can have important implications for measuring productivity trends. *The views expressed in this paper are those of the author and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System or the Board of Governors. These features are highlighted in Kydland and Prescott (1982), Hansen (1985), King, Plosser and Rebelo (1988a,b), for example. One such simple monetary extensions (incorporating cash-in-advance constraints, for example) is Cooley and Hansen (1989). The effects of supply shocks on current account dynamics in two-country models is highlighted in Backus, Kehoe and Kydland (1994). -1What Happens When the Productivity Growth Trend Changes?: Modeling the Dynamics of the “New Economy” The performance of the U.S. economy during the1990s has been universally hailed as stellar. The current expansion is close to surpassing the record for longevity, with strong output and employment growth continuing long past the point that most expansions run out of steam. More significantly, there are no apparent signs of emerging imbalances that might threaten to bring this favorable environment to an end. Inflation has remained subdued, capacity utilization has stayed relatively low, and despite the rapid growth of employment, wage pressures do not appear to be outstripping the pace of productivity growth. It is plausible to conjecture that favorable supply shocks underlie the expansion of the 1990s. In a typical “real business cycle” (RBC) model, positive productivity shocks give rise to temporary expansions of output and factor demands, implying rising employment and investment. In monetary extensions, real supply shocks are associated downward pressure on prices, and multi-country versions of this type of model suggest the emergence of a current account deficit as strong investment demand outstrips domestic saving. These predictions are all suggestive of prominent features of the 1990s economy.