The effect of the financial crisis on TFP growth: a general equilibrium approach

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 27 June 2014

Working Paper No. 502
By Stephen Millard and Anamaria Nicolae

In this paper, we use a simple endogenous growth model to show how a financial crisis might have a permanent effect on the level of total factor productivity (TFP). In the model, a financial shock leads to a rise in the spread between the rate of interest paid by firms and the risk-free rate. Since firms have to borrow to finance their research and development (R&D) spending, such a rise in the spread leads to a fall in R&D spending, which affects innovation and, hence, reduces TFP growth. In turn, this leads to permanent falls in the levels of output and labour productivity.

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