| Summary: | The Great Recession has resulted in a seemingly permanent level shift in many
macroeconomic variables. This paper presents a microfounded general equilibrium
model featuring frictional labour markets and financial frictions that is able
to replicate the business cycle features of establishment dynamics and generate
the procyclicality of R&D expenditures. This makes it possible to demonstrate the
channels through which productivity and financial shocks influence the aggregate
endogenous growth rate of the economy, creating level shifts in its balanced growth
path. The results indicate that financial shocks are an important driver of aggregate
fluctuations and their influence is especially pronounced for establishment entry.
Since the growth rate of the economy can in principle be affected by policy measures,
the macroeconomic and welfare effects of applying several subsidy schemes
are examined. Subsidising R&D expenditures and lowering barriers to entry were
found to be welfare improving, in line with endogenous growth literature. At odds
with this literature, static subsidies to incumbents’ operating costs were also found
to be welfare improving, a result that only emerges under the stochastic setting.
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