The University of Manchester Discussion Paper Series Growth , Cycles and Stabilisation Policy

This paper presents an analysis of the joint determination of growth and business cycles with the view to studying the long-run implications of short-term monetary stabilisation policy. The analysis is based on a simple stochastic growth model in which both real and nominal shocks have permanent effects on output due to nominal rigidities (wage contracts) and an endogenous technology (learning-by-doing). It is shown that there is a negative correlation between the mean and variance of output growth irrespective of the source of fluctuations. It is also shown that, in spite of this, there may exist a conflict between short-term stabilisation and long-term growth depending on the type of disturbance. Finally, it is shown that, from a welfare perspective, the optimal monetary policy is that policy which maximises long-run growth to the exclusion of stabilisation considerations.