Time to Innovate and Aggregate Fluctuations: a New Keynesian Model with Endogenous Technology

This paper develops and estimates a new Keynesian (NK) model with endogenous technological change and explores, by means of Monte Carlo simulations, the role of endogenous technology in macroeconomic fluctuations. This paper shows that introducing endogenously-determined technology can solve three important puzzles faced by conventional NK models. The first is the "inflation persistence puzzle." The paper explains the persistence in inflation without relying on the ad hoc and empirically inconsistent assumptions made by conventional NK models. The second is the "disinflationary news shock puzzle." It explains the disinflationary effect of a news shock, which conventional NK models have difficulty explaining. The third is the "zero lower bound (ZLB) supply shock puzzle." The model avoids the conventional NK models f paradoxical, empirically inconsistent prediction that a negative supply shock is expansionary at the ZLB on nominal interest rates.