Central bank interest-rate increases have a substantial impact on innovation, which in turn can affect the productive capacity of an economy, according to a paper presented Friday at the Federal Reserve’s annual economic policy symposium.
(Bloomberg) — Central bank interest-rate increases have a substantial impact on innovation, which in turn can affect the productive capacity of an economy, according to a paper presented Friday at the Federal Reserve’s annual economic policy symposium.
Monetary-policy tightening both reduces firms’ incentive to innovate by decreasing overall demand, and curtails financial investment through less optimal financial conditions and reduced appetite for risk taking, economists Yueran Ma and Kaspar Zimmermann found. Ma presented the paper at the conference in Jackson Hole, Wyoming, hosted by the Kansas City Fed.
“The results suggest that monetary policy could have a persistent influence on the productive capacity of the economy, in addition to the well-recognized near-term effects on economic outcomes,” wrote the University of Chicago’s Ma and Zimmermann, from the Leibniz Institute for Financial Research SAFE in Frankfurt.
An interest-rate increase of 1 percentage point leads to a 1% to 3% drop in spending on research and development and a 25% decline in venture capital investment in the next one to three years, the authors found.
Patenting also decreases, falling by as much as 9% in the next two to four years for top newer technologies. This could drive an output decline of 1% in the five years following the tightening.
Central banks around the world have raised interest rates to try and cool inflation that was in part driven by outsize demand as economies emerged from the Covid-19 pandemic.
The authors wrote that it may be worthwhile to explore ways to try to counteract the impact of a tighter monetary policy on innovation, through the use of mechanisms such as grants or subsidies.
“Relaxing supply-side constraints may also reduce marginal costs and inflationary pressures,” the authors wrote.
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