Endogenous Growth and Stochastic Trends

This paper shows that in a cross section of countries there exists a strong positive correlation between long-term growth rates and the persistence of output fluctuations. We argue that the traditional explanation of persistence, an RBC model with exogenous productivity shocks, cannot account for this correlation. What is required is a model where the stochastic nature of the trend is endogenous and growth dynamics is an important component of the transmission of business cycles. We present a stylized endogenous growth model with exogenous cyclical shocks where, despite the cyclical nature of the shocks, output fluctuations are persistent and the degree of persistence is an increasing function of long-term growth rates.