Technological advance has a direct effect on the production possibilities frontier and on the market for loanable funds. Although a typical technological innovation occurs in one or a few markets, it allows, through resource reallocation, for increases in the production possibilities all around. That is, the frontier shifts outward (and possibly experiences a change in shape depending on the specific nature of the change in technology); the demand for loanable funds shifts to the right, as business firms take advantage of the new technological possibilities. The resulting higher incomes cause the supply of loanable funds to shift to the right as well.
The direction of movement of the interest rate is indeterminate, depending, as it does, on the relative magnitudes of the shifts in supply and in demand. This indeterminacy, however, presents us with no fundamental puzzle. It simply derives from the fact that the net gain attributable to the technological advance can be realized in part as greater consumption in current and near-future periods and in part as greater consumption in the more remote periods. Although the specific nature of the change in technology may set limits on the particular way in which the gains can be realized, there remains much scope for trading current consumption and future consumption against one another. The advance in technology, whatever its particulars in terms of the timing of inputs and outputs, serves, in effect, to increase the potential of investable resources. To use the old Classical terminology, it is as if the subsistence fund had increased. There will almost always be ample opportunities to draw down the subsistence fund in ways not directly related to the change in technology (for instance, by decreasing current inventories of consumption goods) so as to take immediate advantage of the technological advance. While the rate of interest may rise temporarily while the economy is adjusting to the new technology, it is not necessarily the case — as it is in other macroeconomic constructions — that a (positive) technology shock causes the equilibrium rate of interest to rise.
Figure 4.1 depicts technology-induced growth in an instance where the technological change is interest-rate neutral. Here, we can identify two cases: (1) the technological advance affects all stages of production directly and proportionally, so that no reallocation of resources among the different stages is called for; and (2) scope for resource reallocation allows the implementation of technology that is usable only in one or a few stages to have an immediate or nearly immediate impact on current consumption. In either case, the economy's growth path would be shifted upward but would not otherwise change. The initial and subsequent equilibria are shown by the solid points in Figure 4.1. In the first case, there is no reason to believe that the interest rate would rise even temporarily. Investment, output, income, consumption, and saving would all rise together without putting pressure one way or the other on the rate of interest. In the second case, the demand for loanable funds rises first as producers seek to take advantage of new technology that directly affects, say, an early stage of production. The increase in investment is shown in Figure 4.1 by a rightward shift in the demand for loanable funds from D to D'. The interest rate rises, as indicated by the hollow point marking the intersection of S and D'. (Note also that the adjustment path between the initial PPF (t0) and the subsequent PPF (ti) exhibits an initial investment bias.) Because the technological advance occurred in an early stage, consumable output does not experience an immediate increase. However, the increased interest rate causes resources not directly involved in implementing the new technology to be reallocated towards the late and final stages of production, which allows consumption to increase. As incomes increase (due to increased investment spending) and consumption increases (due to resource reallocations), saving also increases. The supply of loanable funds shifts from S to S', and the interest rate is driven back to its initial level.
Apart from its showing the temporary increase in the rate of interest and the correspondingly bowed-out adjustment path between the two PPFs, our Figure 4.1, depicting technology-induced growth, is virtually identical to Figure 3.8, which depicts secular growth. We might as well have simply modified Figure 3.8 (p. 54) to show a discontinuity in consumable output
occurring at the time of the change in technology. For instance, the set of curves labeled t2 (in Fig. 3.8) could be relabeled t' indicating that a technological advance that had occurred in period tx allowed the economy to experience two years' worth of secular growth in a single year.
The notion that the economy experiences smooth secular growth has always been something of a fiction. By their very nature technological advances occur at irregular intervals and with some advances more dramatic than others. Knut Wicksell ( 1962: 165-77) relied on this irregularity to help reconcile observed movements in the rate of interest and the level of prices and to give plausibility to his rocking-horse theory of the business cycle. Joseph Schumpeter ( 1961: 57-64) featured the irregularity in his theory of economic development. Modern proponents of real business cycle theory (Nelson and Plosser, 1982) point to irregular technological shocks as the source of the variation of output that appears - but only appears - to be cyclical in nature. That is, for real business cycle theorists, what looks like cyclical variation may be nothing but the market's response to changes in technology.
Although a technological change is conceived as being interest-neutral in the comparative-statics sense, it is quite possible for the market process that takes a capital-intensive economy from one equilibrium to another to involve high interest rates for a substantial period. Unlike our second case above involving only a transitory change in the interest rate, the application of new technology may require committing resources to capital-intensive and hence time-consuming production processes in circumstances where the scope for reallocating other resources toward the late stages is limited. In this case, the increased demand for loanable funds may have a dominating effect on the interest rate for some time. Alternatively stated, if the increased supply of loanable funds is not fully accommodating (because higher-priced consumer goods have claimed a larger portion of incomes), the interest rate will rise, serving as a partial brake against fully exploiting the technological advance. The structure of production is being pushed in the direction of increased production time by the technological change itself and pulled in the opposite direction by people's reluctance to forgo current consumption.
It is possible to conceive of a technological change that causes the rate of interest to fall during the adjustment process. Imagine the discovery of some simple process that can quickly and almost effortlessly convert kudzu (a worthless vine that blankets the south-eastern United States) into grits and other consumables. The immediate result of the new technology is that income earners are awash in current consumption. With demands for current output more fully satisfied than before, they willingly put more of their incomes at interest. The increase in the supply of loanable funds lowers the rate of interest and channels funds into the implementation of longer-term projects, using technology that, though not new, can only now be profitably implemented. The fact that the kudzu-to-grits technology seems a bit contrived gives plausibility to the more common association between technological advance and a (temporarily) higher interest rate.
As suggested by our reference to Figure 3.8, tracking the changes of the macroeconomic magnitudes after a technological innovation requires that these changes be superimposed onto the secular growth that the economy was experiencing even before the innovation. It may well be that the initial increase in the interest rate, which acts as a brake on the rate at which technological advance is exploited, is followed by a decrease in the interest rate, as the accelerated accumulation of wealth (relative to accumulation prior to the innovation) is accompanied by a change in intertemporal consumption preferences. Allowing for this effect (from innovation to increased wealth to lower time preferences), we see technological innovation as causing the equilibrium rate of interest to fall even though the adjustment to this new equilibrium may involve a temporarily high interest rate. More importantly for the application of our capital-based macroeconomic framework, the economy's pattern of growth, as boosted by the technological advance, is a sustainable one. That is, the change in the underlying economic realities imply an altered growth path; the market process translates the technological advance into the new preferred growth path; and there is nothing in the nature of this market process that turns the process against itself.
The possible consequences of an increase in resource availabilities are similar to those of technological advance. Discovering new mineral deposits is equivalent in many respects to discovering new and better ways of extracting minerals from old deposits. In either case, the economy's postdiscovery growth path is sustainable in the above-mentioned sense. In each instance of increased resource availabilities and technological advance, the specifics of the market process triggered by the parametric change depend on the specifics of the parametric change itself. Apart from our suggested reinterpretation of Figure 3.8 and the incorporation of the wealth effects on intertemporal consumption preferences and hence on the interest rate, the attempt to identify and deal further with some general case is not likely to be worthwhile.
In contrast to changes in technology and resource availabilities, a change in intertemporal consumption preferences has consequences for which the direction of change in the rate of interest and related macroeconomic magnitudes is determinate and for which a general case can be identified. Further, the parallels between the consequences of a change in intertemporal preferences and the consequences of a policy of credit expansion by the monetary authority give special relevance to these preference changes and policy actions.
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