While accommodative monetary policy can promote economic activity it may slow productivity growth by allowing unproductive firms to survive, according to the latest issue of the Federal Reserve Bank of Kansas City's
A "surprise" increase in accommodation reduces the number of firms going out of business, but doesn't "significantly" raise the number of new businesses, according to Willem Van Zandweghe, assistant vice president and economist at the Kansas City Fed, and Yoonsoo Lee of Sogang University, authors of the report, which results in a decrease on the shifting of capital and workers from disbanding companies to new ones.
"To the extent the lower rate of reallocation weighs on productivity, these effects could offset some of the possible positive supply-side effects of a surprise increase in policy accommodation stemming from higher investment and labor force participation," the Bulletin says.
Several researchers, the Bulletin says, have gradually lowered estimates for potential output "as the extent of the recession's supply-side damage becomes clear." If the damage results from weak demand, it can be corrected by the Federal Open Market Committee making policy "unusually accommodative," the authors write.
Discouraged workers drawn into a tight labor market, expand "the trend labor supply and thus potential output," while a booming economy allows firms to invest in plants, equipment and intellectual property so output goes up from "higher trend productivity."
On the downside, could lower trend labor productivity by letting unproductive firms remain in business.
