Endogenous Growth and Stochastic Trends

This paper shows that there exists a strong positive correlation between long-term growth rates and the persistence of output fluctuations in a cross section of countries. We argue that the traditional explanation of persistence, a real business cycles model with exogenous productivity shocks, cannot produce this correlation. We propose an explanation based on an endogenous growth model with exogenous cyclical shocks. We find that, despite the cyclical nature of the shocks, output fluctuations are persistent and the degree of persistence is an increasing function of long-term growth rates. Growth dynamics become an important component of the transmission of business cycles. We conclude that the analysis of economic fluctuations in models where technological progress is assumed to be exogenous can be misleading.