Central bank efforts to slow inflation, by raising borrowing costs and cooling demand for goods and services, may also undermine investments in innovative technologies that could make the economy stronger in the long-run, according to research presented on Friday at a Federal Reserve economic symposium.
Yueran Ma, an economist at the University of Chicago Booth School of Business, and Kaspar Zimmermann, an economist at Germany's Leibniz Institute for Financial Research SAFE, found that an unanticipated 1-percentage-point tightening of monetary policy cut company research and development spending by up to 3%, reduced venture capital spending by an even deeper 25%, and reduced patents in what were considered "important" technologies by 9%.
After five years, overall economic output was about 1% lower than it would have been, a finding they regard as evidence of how a central bank's focus on curbing inflation in the short-run "could have a persistent influence on the productive capacity of the economy." Their paper was presented at the U.S. central bank's annual conference in Jackson Hole, Wyoming.
Economists and central bankers usually regard monetary policy as a short-term tool used to stabilize output and inflation, with loose financial conditions when an economy is faltering and higher borrowing costs when prices begin to accelerate.
In the case of monetary tightening, however, the authors said the hit to demand may leave companies with less incentive to innovate, while higher interest rates may make safer investments more attractive and sap the sort of risk appetite that drives venture funding.
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Financial conditions can't hold back the "technological waves" that come along occasionally in the form of widespread electrification, for example, or the diffusion of information technology that took root during the period of high inflation and rising interest rates in the 1980s.
But their finding is relevant in an era in which productivity has been improving only slowly and Fed officials regard the economy's underlying growth potential as limited. Improving productivity boosts growth while lowering inflation risks at the same time.
Still, the researchers did not suggest that central banks should become "dovish" in an effort to spur innovation or nurse the supply side of the economy at the expense of meeting inflation goals.
"We do not think our findings necessarily imply that monetary policy should be more dovish. It is well recognized that efforts seeking to perennially stimulate the economy with monetary easing can be ineffective or counterproductive," they said, suggesting that fiscal tools could instead be used to sustain innovation when monetary conditions are tightening.
