What Happens when the Technology Growth Trend Changes? : Transition Dynamics, Capital Growth and the "New Economy

The rapid increase in U.S. economic growth during the late 1990s inspired speculation that an acceleration in the rate of technological progress had given rise to an increase in potential output growth. This paper considers the transition dynamics associated with such a change using a general equilibrium framework that incorporates stochastic growth trends. The model suggests that transition dynamics associated with a shift in the technological growth trend can have important implications for macroeconomic growth patterns, particularly when technological change is investment-specific. Simulations of the post-WWII U.S. economy show that the model’s internal propagation mechanism is capable of explaining a significant portion of the variation in growth rates over the sample period, particularly for investment, capital accumulation, and employment. *This paper has been prepared for the Federal Reserve Bank of New York conference “Productivity Growth: A New Era?” November 2, 2001. Rachel Mandel provided invaluable research assistance. 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. -1What Happens When the Technology Growth Trend Changes?: Transition Dynamics, Capital Deepening and the “New Economy” Introduction The increase in productivity growth during the late 1990s has raised the issue of whether a fundamental change has taken place in the U.S. economy. Although many economists remain skeptical about “new economy” or “new paradigm” theories that have emerged in this context, the conjecture that there has been a shift in the potential growth trend has been seriously entertained. Indeed, the issue is often cast in terms of whether recent trends suggest a return to growth conditions prior to the productivity growth slowdown that apparently began in the early 1970s. In this paper, I examine the implications a change in the trend rate of technological progress in the context of a simple general equilibrium model that incorporates stochastic growth trends. The model illustrates a potentially important but often overlooked source of dynamics associated with such a change: the transition dynamics due to a change in the optimal capital/labor ratio. Simulations of the model’s responses to growth shocks suggest that long-run adjustment of the capital stock to changes in underlying growth trends gives rise to persistence in the model’s dynamics, so that changes in the growth rate of technological progress may not be clearly manifested in measured productivity data for several years after the event. Moreover, the inverse relationship between the capital/labor ratio and the underlying growth trend implicit in the model’s dynamics implies non-monotonic convergence paths for the growth rates of key macroeconomic variables.