Monetary Policy and Economic Growth in a Schumpeterian Model with Incumbents and Entrants

An important aspect of economic growth is the interaction between incumbents and new firms. In this study, we develop a monetary Schumpeterian model with an endogenous market structure (EMS) and two types of quality improvements (the own-product improvements of incumbents and creative destruction of entrants) to analyze the effects of monetary policy. The key finding of our analysis is that an increase in the nominal interest rate importantly affects the composition of innovation that drives economic growth, stimulating the incumbents’ own-product improvements and reducing the entrants’ creative destruction. Therefore, the growth effect of monetary policy is ambiguous, and depends on the relative magnitudes of the incumbents’ and entrants’ contributions to R&D and growth. Finally, we provide a quantitative analysis of the growth and welfare effects of monetary policy and consider an extension of the benchmark model with an elastic labor supply and a CIA constraint on consumption.