RDP 2024-01: Do Monetary Policy and Economic Conditions Impact Innovation? Evidence from Australian Administrative Data 7. Conclusion

There is a small but growing literature arguing that macroeconomic conditions and monetary policy shocks can have medium-run effects on productivity, and therefore living standards and economic activity. This has important implications for macroeconomic policy. While such effects are likely to cancel out over a business cycle, the potential for medium-run productivity scarring increases the importance of macro stabilisation policy. It also increases the costs associated with such policies being constrained, such as at the effective zero lower bound on interest rates. And it potentially alters the trade-offs a central bank faces when stabilising inflation and activity in the face of supply shocks, provided that inflation expectations can be kept anchored.

We provide the first evidence on the potential medium-run effects of monetary policy shocks and (indirectly) of economic conditions for a small open economy that imports innovation, rather than a large economy that creates it. Consistent with the overseas literature, we find evidence for Australia that contractionary (expansionary) monetary policy shocks are associated with a decline (increase) in R&D spending. We also find that declines (increases) in R&D spending are associated with lower (higher) levels of productivity in the medium term, though identifying the effects of R&D spending on productivity is more challenging.

When focusing on broader measures of innovation that may better capture adoption of technologies, a key driver of productivity growth, we find substantial heterogeneity in the response of firms. SMEs are less likely to innovate and adopt after a contractionary monetary policy shock, but large firms are more likely to do so. This appears to reflect the fact that SMEs and large firms have differing exposures to the various channels through which monetary policy can affect innovative activity. For example, exporting firms (which tend to be larger) are less likely to lower their innovative activity following a contractionary monetary policy shock, seemingly because they are less exposed to the ensuing softening in domestic demand. As such, monetary policy appears to affect innovation by affecting demand in the economy – so via the demand channel of monetary policy. Contractionary monetary policy shocks also lead to an increase in the share of firms (particularly SMEs) reporting that financial constraints are preventing them from innovating. As such, monetary policy also appears to affect innovation by influencing financial conditions and constraints – so via the financial channel of monetary policy.

A further novel aspect of our paper is considering the effects of US monetary policy shocks on the innovative activity of Australian firms. We find important spillovers from US monetary policy shocks onto the innovation activity of Australian firms. This effect is larger for Australian firms who export, again consistent with the demand channel of monetary policy.

Our results confirm that monetary policy, both domestic and foreign, and economic conditions can have medium-run effects on productivity and output by influencing the amount of innovative activity that occurs. However, they do not speak to the longer-run structural decline in productivity growth observed over the past two decades. Previous work has shown that this reflects structural declines in labour mobility, technology adoptions and competition which appear unrelated to the economic cycle (e.g. Andrews and Hansell 2021; Andrews et al 2022; Hambur 2023).