US Federal Reserve Bank Attempts to Ease Inflation Might Stifle Innovation, Report Claims

The Federal Reserve Bank’s ongoing efforts to ease inflation by increasing net borrowing costs and then cooling demand for products/services could begin to undermine investments in innovative tech that might make the economy more robust in the long-term. This, according to research released this past Friday during a US Federal Reserve economic symposium.

Yueran Ma, an economist who’s working at the University of Chicago Booth School of Business, and Kaspar Zimmermann, an economist at Germany’s Leibniz Institute for Financial Research SAFE, revealed that an expected 1% tightening of monetary policy slashed company research and development spending by as much as 3%, lowered VC spending by a steep 25%, and lowered patents in what were deemed to be vital technologies by around 9%.

After about five years, the total economic output has been around 1% lower than it could have been, a key finding they consider to be evidence of how a reserve bank’s focus on addressing inflation in the short-term may have a “persistent influence” on the productive capacity of the economy.

As first reported by Reuters, their research paper was shared at the US Reserve Bank’s conference that had been held in Jackson Hole, Wyoming.

Economists and reserve bankers typically think of monetary policy as a type of short-term tool used to stabilize output and address inflation, with fairly loose financial conditions when an economy is failing and greater borrowing costs when prices start to accelerate.

As it pertains to monetary tightening, the research authors stated that the hit to demand could leave firms with considerably less incentive to try to innovate; meanwhile, greater interest rates could make significantly safer investments more appealing and then tap into the type of risk appetite that promotes venture funding.

Financial conditions might not be able to hold back the “technological waves” that tend to come along at times, in the form of electrification, for instance, or even the diffusion of information tech, which may have taken root during the period of relatively high inflation and increasing interest rates back in the ’80s.

However, their findings are relevant during a period in which productivity has been improving at a rather slow pace, and Fed officials regard the economy’s overall growth potential as fairly limited. Increasing overall productivity stimulates growth while decreasing inflation risks simultaneously.

Despite this, the research team has not indicated that reserve banks could begin to become “dovish” in an attempt to support innovation or deal with the supply side of the evolving economy at the cost of addressing inflation targets.

As noted in the update:

“We do not think our findings necessarily imply that monetary policy should be more dovish. It is well recognized that efforts seeking to perennially stimulate the economy with monetary easing can be ineffective or counterproductive.”

This indicates that fiscal tools may be utilized to support innovation at a time when monetary conditions are continuously tightening.

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