MNI: US Potential Lower Post Fed Tightening-Jackson Hole Paper

Tighter Federal Reserve policy could reduce innovation and hurt the U.S. economy's productive capacity according to research presented Friday at the Kansas City Fed's Jackson Hole conference, with the authors saying that result doesn't imply policymakers should be more dovish.

After a tightening shock of 100 basis points, based on previous estimates of the sensitivity of output to innovation, output could be 1% lower after five years, according to a paper by Yueran Ma and Kaspar Zimmermann.

"Monetary policy can influence innovation activities by changing aggregate demand and correspondingly the profitability of innovation, and by changing financial market conditions," the authors write.

A one percentage point increase in the fed funds rate leads to a 1% to 3% decline in R&D spending and a 25% fall in VC investment over one to three years. Patenting of important technologies declines up to 9% in two to four years. By decreasing demand, monetary policy tightening can reduce the profitability of developing new products and the incentives to innovate, and monetary policy tightening can affect financial conditions and reduce the appetite for risk taking, the authors write.

Since Fed rate hikes began in 2022, VC investment has dropped about 30% annually from a peak in 2021. The decline is present in all major sectors, the authors say, also acknowledging the recent breakthroughs in AI raise the hope of another technological revolution.