Creative Destruction Cycles: Schumpeterian Growth in an Estimated DSGE Model

In this paper I incorporate a Schumpeterian mechanism of creative destruction in a standard DSGE framework. In the model, a sector of forward-looking profit maximizing innovators determines the economy’s TFP growth rate. I estimate the model with Bayesian methods, and show that models featuring an endogenous TFP channel can empirically outperform models that exhibit standard, exogenous productivity dynamics. The paper provides a comprehensive comparative assessment of the impact of the endogenous TFP channel in an estimated fully-fledged DSGE model. The variance decomposition analysis shows that endogenous TFP is a powerful channel of transmission of adverse shocks throughout the business cycle. The estimates suggest that the 35% of the productivity growth rate fluctuations had endogenous origins during the Great Recession.