Persistent slumps: Innovation and the credit channel of monetary policy

Monetary policy is increasingly found to exert long-run effects on the aggregate economy. We investigate the long-term effects of monetary policy through the credit channel. We develop a dynamic general equilibrium model with financial intermediaries and endogenous innovation in which credit frictions constrain firms’ investment and R&D expenses. Following an adverse monetary shock, the tightening of credit conditions for the innovation sector generates sizeable long-term effects, turning the shock into a persistent stagnation. We quantify the contribution of this transmission channel to productivity and output hysteresis. We then characterize the monetary policy trade-offs between short- and long-term targets, showing that the control of inflation can entail a growth slowdown. The results are consistent with Bayesian VAR estimates of the responses of credit and innovation aggregates to monetary shocks.