Stagnation Traps in an Open Economy

In this paper, we construct a continuous time endogenous growth model in which innovation is the engine of growth, and study the effect of trade restriction on the employment and the growth rate. In our model, the nominal wage rate has downward rigidity, and therefore the model may have involuntary unemployment. Monetary policy is determined by the Taylor rule. We first show that there are two balanced growth paths. In one path, the workers are fully employed and the nominal interest rate is positive. In another path, some workers are unemployed and the nominal interest rate is zero. We next show that, in the unemployment equilibrium, trade restriction by raising tariffs may lower the unemployment rate without reducing the economic growth rate. However, increasing the tariff rate excessively reduces the growth rate without improving the labor market.