ASSET PRICE BUBBLES AND TECHNOLOGICAL INNOVATION

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)