An R&D-based real business cycle model

Abstract

The New Keynesian Real Business Cycle model with staggered price adjustment is augmented with a R&D producing sector. Two sources of economic shocks are considered, namely random participation (perturbances to value of alternative investment opportunities in another sector) and financial intermediation (shocks to the cost of raising capital in the financial intermediation market). We find that, when comparing to the baseline model, both models can explain pro-cyclical R&D spending. Additionally, the investment oversensitivity problem is corrected. However, only the financial intermediation model is consistent with the observed finding that volatility of R&D is larger than that of investment and output.