Sunspots, Coordination, and Innovation Cycles

I propose a theoretical mechanism that offers a possible explanation for the post-Great Recession stagnation experience observed in many industrialized countries. The theory is based on failures in the coordination of the beliefs of productive and innovative agents. In the model, an innovative sector determines endogenously the long-run growth rate of the economy, and research exhibits positive spillovers. Failing to internalize the general equilibrium effects of their innovation decisions, agents can coordinate into pervasive equilibria in which no innovation occurs, which leads the economy to growing through lowerand older-quality production for as long as pessimism persists. Through simulations, I show that the model can generate patterns that are qualitatively similar to those experienced by the U.S. output and private R&D investment since the 2008 financial crisis. In particular, output drops on impact due to the endogenously generated, belief-driven recession, and the subsequent recovery is sluggish and settles around a trend that is both lower and flatter than its pre-crisis level. ∗New York University, Department of Economics: 19 W 4th street, 10012 New York, NY. I am thankful to Edouard Schaal and Jess Benhabib for their guidance and advice. I also thank Laurent Cavenaile, Diego Daruich, Miguel de Faria e Castro, Julian Kozlowski, Ilse Lindenlaub, and Ewout Verriest for valuable comments and suggestions at different stages of the project. All errors are my own. Comments are very welcome. E-mail: [email protected].