Abstract: We introduce borrowing constraints into a two‐sector Schumpeterian growth model and examine the impact of asset price bubbles on innovation. In this environment, rational bubbles arise when the intermediate good producing R&D sector is faced with adverse productivity shocks. Importantly, these bubbles help alleviate credit constraints and facilitate innovation in the stagnant economy. On the policy front, we make a case for debt financed credit to the R&D sector. Further, we establish that a constant credit growth rule (akin to the Friedman rule) outperforms the often prescribed counter‐cyclical “lean against the wind” credit policy. (JEL E32, E44, O40)

Authors’ Names:  Jong Kook Shin and Chetan Subramanian

Journal Name: Economic Inquiry

Publication Details: Wiley Online Library

Article first published online: 16 July 2018

URL: https://onlinelibrary.wiley.com/doi/abs/10.1111/ecin.12695