International Models of Growth

Project Start:07/2014
Researchers:Giuliano Curatola, Michael Donadelli, Alessandro Gioffré, Patrick Grüning, Christian Schlag
Category: Financial Markets
Funded by:LOEWE

Topic & Objectives

The 2008-2009 global demand collapse and the more recent EU sovereign debt crises have forced fiscal and monetary authorities both in the US and in the EU to implement “drastic/unconventional” policies. However, the benefits in terms of welfare and economic growth of such policies are still missing, in particular among EU member countries. The non-effectiveness of implemented fiscal policies may be the result of a relatively high degree of heterogeneity among EU member states. It is widely accepted that EU member states exhibit structural differences such as heterogeneous labor markets and asymmetric tax regimes. Structural cross-country asymmetries not only affect the expected outcome that a policy may have on a single country but also on the EU as a whole. An example is the European Stability and Growth Pact, which forces all EU member countries to have balanced budgets. In order to stick to this common rule some EU countries raised taxes or cut public spending. Given the importance of international diffusion of technologies in stimulating growth, a non-efficient tightening of fiscal policies may lead to sizable domestic and foreign long-run economic growth losses, in particular if productive spending is undermined.

In an endogenous growth setting, we first examine the effects of fiscal consolidation on economic growth. In the presence of a zero-deficit policy rule (i.e., fiscal consolidation regime) we show that a cut in R&D investments has non-negligible effects on both short- and long-run growth. Moreover, fiscal consolidation hampers economic growth in the presence of either an aggregate productivity shock or a government spending shock (see SAFE WP No. 56).

In a shorter paper, we show that endogenous labor market dynamics are important for both macro-quantities and asset prices. Precisely, we show that the inclusion of endogenous labor and real labor market rigidities in a stochastic version of the Romer (1990) economy leads to a rise in the equity risk premium and higher labor growth volatility, consistent with empirical evidence (see Donadelli/Grüning, 2016).

In an international setting – where growth is sustained by both domestic R&D investments and international adopted technologies – asymmetries in labor markets and fiscal policy regimes allow us to (endogenously) capture the empirically observed differences in main asset prices and macro moments. Moreover, these asymmetries alter the transmission mechanism in the presence of adoption probability shocks. Our novel international setting confirms (quantitatively) that international adoption is key for stimulating global growth. In particular, we observe that a domestic adoption probability shock affects both domestic and foreign macroeconomic aggregates (see SAFE WP No. 163).

In another two-country endogenous growth economy with complete and frictionless capital markets and international trade we also show that novel technology spillovers help to explain a number of domestic and international asset pricing and macroeconomic anomalies (see SAFE WP No. 83).

Key Findings

  • In the presence of tight fiscal policy rules R&D spending should be stimulated. If not, countries incur long-run growth losses. This may have contagion effects.
  • Real labor market dynamics are key to closer fit both financial and macro data. In this respect, standard production economies have to account for such dynamics. More importantly, international models should account for differences across countries’ labor market structures.
  • Heterogeneity in the degree of wage rigidities as well as in the flexibility of fiscal policies across countries help to capture the empirically observed differences in asset prices and macro-quantities.

Policy Implications

R&D spending and international technology adoption are key for stimulating growth. Investments in education, research, innovation and energy should therefore be prioritized and strengthened, in particular among weak countries. Moreover, fiscal and monetary authorities should account for the role of real rigidities in labor market dynamics. More importantly, cross-country differences in labor markets and fiscal regimes have first order implications once a coordinated policy is implemented.

Related Published Papers

Author/sTitleYearProgram AreaKeywords
Michael Donadelli, Patrick GrüningLabor Market Dynamics, Endogenous Growth and Asset Prices
Economics Letters
2016 Financial Markets
Patrick GrüningInternational Endogenous Growth, Macro Anomalies, and Asset Prices
Journal of Economic Dynamics and Control
2017 Financial Markets Innovation, Technology spillover, Endogenous growth, Long-run risk, International finance

Related Working Papers

No.Author/sTitleYearProgram AreaKeywords
163Giuliano Curatola, Michael Donadelli, Patrick GrüningTechnology Trade with Asymmetric Tax Regimes and Heterogeneous Labor Markets: Implications for Macro Quantities and Asset Prices2017 Financial Markets Technology Adoption, R&D Investment, Asymmetric Tax Regimes, Asset Prices
185Patrick GrüningHeterogeneity in the Internationalization of R&D: Implications for Anomalies in Finance and Macroeconomics2017 Financial Markets Heterogeneous innovation, Technology spillover, Endogenous growth, Creative destruction, International finance
56Giuliano Curatola, Michael Donadelli, Alessandro Gioffré, Patrick GrüningAusterity, Fiscal Uncertainty, and Economic Growth: Insights from Fiscally Weak EU Countries2014 Financial Markets Austerity Measures, Fiscal Policy, Endogenous Growth, R&D
83Patrick GrüningInternational Endogenous Growth, Macro Anomalies, and Asset Prices2015 Financial Markets Innovation, Product Market Competition, Endogenous Growth, Long-run Risk, International Finance