Technology Innovation and Di¤usion as Sources of Output and Asset Price Fluctuations

Starr Center and the NSF is greatly appreciated. We develop a model in which innovations in an economys growth potential are an important driving force of the business cycle. The framework shares the emphasis of the recent "new shock " literature on revisions of beliefs about the future as a source of uctuations, but di¤ers by tieing these beliefs to fundamentals of the evolution of the technology frontier. An important feature of the model is that the process of moving to the frontier involves costly technology adoption. In this way, news of improved growth potential has a positive e¤ect on current hours. As we show, the model also has reasonable implications for stock prices. We estimate our model for data post-1984 and show that the innovations shock accounts for nearly a third of the variation in output at business cycle frequencies. The estimated model also accounts reasonably well for the large gyration in stock prices over this period. Finally, the endogenous adoption mechanism plays a signi\u85cant role in amplifying other shocks