Long-Run Consequences of Business-Cycle Fluctuations

The UK economy is suffering from low growth. According to the International Monetary Fund World Economic Outlook forecasts published in January 2023, not only will the UK be the country with the lowest GDP growth among the G7s over the next two years, but the G7s are also expected to grow the least in the world economy over the next five to ten years. Given this abmysal outlook, the British government has recently emphasized the need for policy change, especially at a time in which rising inequality among households and firms has contributed to parts of the UK economy running at different speeds.

However, most of the policies under current consideration by governments and central banks around the world are designed as short-term stabilization tools for the whole economy, and little is known about the distributional consequences of these policies over the longer-term. The research described in this proposal will study the channels through which stabilization policies and business-cycle fluctuations are likely to have longer-lasting effects than previously thought on the aggregate economy and across different groups of society, through the interlinkages between household and firm heterogeneity.

The unifying theme is the notion that the consumption of households with certain economic traits or the investment of firms with particular financial characteristics may drive the sales of another set of companies, and this may affect their labour and capital demand for specific types of workers (e.g. low-skilled vs high-skilled) and specific class of assets (e.g. `tangible' vs `intangible'). This in turn sets in motion a wave of second-round effects that, through their influence on firms' entry & exit and R&D, have the potential to generate a significant impact on aggregate productivity, labour income, and living standards.

This research will look at the two-way interaction between economics and business innovation by evaluating the effects of firm-level R&D and innovation on the aggregate economy as well as the mechanism through which a benign macroeconomic environment (and seeding government policies) can foster innovation in the private sector. Furthermore, the proposal will study the impact of rising commodity prices, mitigation policies against climate change, carbon taxes and green investments on firms' R&D and aggregate productivity across different sectors. Environmental policies are often feared to inhibit productivity and economic growth. The research in this proposal will allow us to identify, evaluate and quantify whether appropriately designed economic policies can boost aggregate productivity over the longer-term through (rather than despite) a government green agenda.

This proposal seeks to have an impact on both academic research and economic policy. On the academic side, we will build a new framework to identify, evaluate and quantify the contribution of second-round effects --working through the interaction of firm and household heterogeneity-to the transmission of economic policies and temporary shocks onto long-run economic growth. On the policy side, we will identify the group of firms/workers/households and the categories of spending that drive most of the the aggregate response of productivity, labour income, employment and consumption. Particular emphasis will be given to assess the longer-term distributional consequences of specific policy interventions (e.g. changes in income taxes, carbon taxes and interest rates) and shocks (e.g. commodity price spikes) among firms, workers and households, so as to identify the sectors and groups of society that gain/lose most by these policies. These findings will provide governments and central banks with a key piece of information to design targeted interventions that could improve the effectiveness of their economic policies.