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slide 1
The lessons of growth theoryThe lessons of growth theory
……can make a positive difference in can make a positive difference in the lives of hundreds of millions of the lives of hundreds of millions of
people.people.These lessons help us understand why poor
countries are poor design policies that
can help them grow learn how our own
growth rate is affected by shocks and our government’s policies
slide 2
Huge effects from tiny differencesHuge effects from tiny differences
In rich countries like the U.S., if government policies or
“shocks” have even a small impact on the
long-run growth rate, they will have a huge impact
on our standard of living in the long run…
slide 3
Huge effects from tiny differencesHuge effects from tiny differences
1,081.4%243.7%85.4%
624.5%169.2%64.0%
2.5%
2.0%
…100 years…50 years…25 years
percentage increase in standard of living after…
annual growth rate of income per capita
slide 4
Huge effects from tiny differencesHuge effects from tiny differences
If the annual growth rate of U.S. real GDP per capita
had been just one-tenth of one percent higher
during the 1990s,
the U.S. would have generated an additional $449 billion of income
during that decade
slide 5
slide 6
Egypt
Chad
Pakistan
Indonesia
ZimbabweKenya
India
CameroonUganda
Mexico
IvoryCoast
Brazil
Peru
U.K.
U.S.Canada
FranceIsrael
GermanyDenmark
ItalySingapore
Japan
Finland
100,000
10,000
1,000
100
Income per person in 1992(logarithmic scale)
0 5 10 15Investment as percentage of output (average 1960–1992)
20 25 30 35 40
International Evidence on Investment International Evidence on Investment Rates and Income per PersonRates and Income per Person
slide 7
Chad
Kenya
Zimbabwe
Cameroon
Pakistan
Uganda
India
Indonesia
IsraelMexico
Brazil
Peru
Egypt
Singapore
U.S.
U.K.
Canada
FranceFinlandJapan
Denmark
IvoryCoast
Germany
Italy
100,000
10,000
1,000
1001 2 3 40
Income per person in 1992(logarithmic scale)
Population growth (percent per year) (average 1960–1992)
International Evidence on Population International Evidence on Population Growth and Income per PersonGrowth and Income per Person
slide 8
Examples of technological progressExamples of technological progress
1970: 50,000 computers in the world2000: 51% of U.S. households have 1 or more computers
The real price of computer power has fallen an average of 30% per year over the past three decades.
The average car built in 1996 contained more computer processing power than the first lunar landing craft in 1969.
Modems are 22 times faster today than two decades ago.
Since 1980, semiconductor usage per unit of GDP has increased by a factor of 3500.
1981: 213 computers connected to the Internet2000: 60 million computers connected to the Internet
slide 9
Policies to promote growthPolicies to promote growth
Four policy questions:
1. Are we saving enough? Too much?
2. What policies might change the saving rate?
3. How should we allocate our investment between privately owned physical capital, public infrastructure, and “human capital”?
4. What policies might encourage faster technological progress?
slide 10
1. Evaluating the Rate of Saving1. Evaluating the Rate of Saving
Use the Golden Rule to determine whether our saving rate and capital stock are too high, too low, or about right.
To do this, we need to compare (MPK ) to (n + g ).
If (MPK ) > (n + g ), then we are below the Golden Rule steady state and should increase s.
If (MPK ) < (n + g ), then we are above the Golden Rule steady state and should reduce s.
slide 11
1. Evaluating the Rate of Saving1. Evaluating the Rate of Saving
To estimate (MPK ), we use three facts about the U.S. economy:
1. k = 2.5 yThe capital stock is about 2.5 times one year’s GDP.
2. k = 0.1 yAbout 10% of GDP is used to replace depreciating capital.
3. MPK k = 0.3 yCapital income is about 30% of GDP
slide 12
1. Evaluating the Rate of Saving1. Evaluating the Rate of Saving
1. k = 2.5 y
2. k = 0.1 y
3. MPK k = 0.3 y
0 12 5..
k yk y
0 10 04
2 5.
..
To determine , divided 2 by 1:
slide 13
1. Evaluating the Rate of Saving1. Evaluating the Rate of Saving
1. k = 2.5 y
2. k = 0.1 y
3. MPK k = 0.3 y
MPK 0 32 5..
k yk y
0 3MPK 0 12
2 5.
..
To determine MPK, divided 3 by 1:
Hence, MPK = 0.12 0.04 = 0.08
slide 14
1. Evaluating the Rate of Saving1. Evaluating the Rate of Saving
From the last slide: MPK = 0.08
U.S. real GDP grows an average of 3%/year,
so n + g = 0.03
Thus, in the U.S.,MPK = 0.08 > 0.03 = n + g
Conclusion: The U.S. is below the Golden Rule steady state: The U.S. is below the Golden Rule steady state: if we increase our saving rate, we will have faster if we increase our saving rate, we will have faster growth until we get to a new steady state with growth until we get to a new steady state with higher consumption per capita.higher consumption per capita.
The U.S. is below the Golden Rule steady state: The U.S. is below the Golden Rule steady state: if we increase our saving rate, we will have faster if we increase our saving rate, we will have faster growth until we get to a new steady state with growth until we get to a new steady state with higher consumption per capita.higher consumption per capita.
slide 15
2. Policies to increase the saving rate2. Policies to increase the saving rate
Reduce the government budget deficit(or increase the budget surplus)
Increase incentives for private saving: reduce capital gains tax, corporate
income tax, estate tax as they discourage saving
replace federal income tax with a consumption tax
expand tax incentives for IRAs (individual retirement accounts) and other retirement savings accounts
slide 16
3. Allocating the economy’s investment3. Allocating the economy’s investment
In the Solow model, there’s one type of capital.
In the real world, there are many types,which we can divide into three categories:– private capital stock– public infrastructure– human capital: the knowledge and
skills that workers acquire through education
How should we allocate investment among these types?
slide 17
4. Encouraging technological progress4. Encouraging technological progress
Patent laws:encourage innovation by granting temporary monopolies to inventors of new products
Tax incentives for R&D
Grants to fund basic research at universities
Industrial policy: encourage specific industries that are key for rapid tech. progress (subject to the concerns on the preceding slide)
slide 18
CASE STUDY: CASE STUDY: The Productivity SlowdownThe Productivity Slowdown
1.5
1.8
2.6
2.3
2.0
1.6
1.8
2.2
2.4
8.2
4.9
5.7
4.3
2.9
1972-951948-72
U.S.
U.K.
Japan
Italy
Germany
France
Canada
Growth in output per person(percent per year)
slide 19
Explanations?Explanations?
Measurement problemsIncreases in productivity not fully measured.– But: Why would measurement problems
be worse after 1972 than before?
Oil pricesOil shocks occurred about when productivity slowdown began.– But: Then why didn’t productivity speed
up when oil prices fell in the mid-1980s?
slide 20
Explanations?Explanations?
Worker quality1970s - large influx of new entrants into labor force (baby boomers, women).New workers are less productive than experienced workers.
The depletion of ideasPerhaps the slow growth of 1972-1995 is normal and the true anomaly was the rapid growth from 1948-1972.
slide 21
The bottom line:The bottom line:
We don’t know which of these We don’t know which of these is the true explanation, is the true explanation,
it’s probably a combination it’s probably a combination of several of them.of several of them.
We don’t know which of these We don’t know which of these is the true explanation, is the true explanation,
it’s probably a combination it’s probably a combination of several of them.of several of them.
slide 22
CASE STUDY: CASE STUDY: I.T. and the “new economy”I.T. and the “new economy”
2.9
2.5
1.1
4.7
1.7
2.2
2.7
1.5
1.8
2.6
2.3
2.0
1.6
1.8
2.2
2.4
8.2
4.9
5.7
4.3
2.9
1995-20001972-951948-72
U.S.
U.K.
Japan
Italy
Germany
France
Canada
Growth in output per person(percent per year)
slide 23
CASE STUDY: CASE STUDY: I.T. and the “new economy”I.T. and the “new economy”
Apparently, the computer revolution didn’t affect aggregate productivity until the mid-1990s.
Two reasons:1.Computer industry’s share of GDP much
bigger in late 1990s than earlier. 2.Takes time for firms to determine how to
utilize new technology most effectively
The big questions: Will the growth spurt of the late 1990s
continue? Will I.T. remain an engine of growth?
slide 24
Money supply measures, Money supply measures, April 2002April 2002
_Symbol Assets included Amount (billions)_
C Currency $598.7
M1 C + demand deposits, 1174.0 travelers’ checks, other checkable deposits
M2 M1 + small time deposits,5480.1
savings deposits, money market mutual funds, money market deposit accounts
M3 M2 + large time deposits,8054.4
repurchase agreements, institutional money market mutual fund balances
slide 25
slide 26
slide 27
slide 28
slide 29
The social costs of inflationThe social costs of inflation
…fall into two categories:
1. costs when inflation is expected
2. additional costs when inflation is different than people had expected.
slide 30
The costs of expected inflation: The costs of expected inflation: 11.. shoeleather costshoeleather cost
def: the costs and inconveniences of reducing money balances to avoid the inflation tax.
i
real money balances
Remember: In long run, inflation doesn’t affect real income or real spending.
So, same monthly spending but lower average money holdings means more frequent trips to the bank to withdraw smaller amounts of cash.
slide 31
The costs of expected inflation: The costs of expected inflation: 22.. menu costsmenu costs
def: The costs of changing prices.
Examples:– print new menus– print & mail new catalogs
The higher is inflation, the more frequently firms must change their prices and incur these costs.
slide 32
The costs of expected inflation: The costs of expected inflation: 33.. relative price distortionsrelative price distortions
Firms facing menu costs change prices infrequently.
Example: Suppose a firm issues new catalog each January. As the general price level rises throughout the year, the firm’s relative price will fall.
Different firms change their prices at different times, leading to relative price distortions…
…which cause microeconomic inefficiencies in the allocation of resources.
slide 33
The costs of expected inflation: The costs of expected inflation: 44.. unfair tax treatmentunfair tax treatment
Some taxes are not adjusted to account for inflation, such as the capital gains tax.
Example: 1/1/2001: you bought $10,000 worth of
Starbucks stock 12/31/2001: you sold the stock for $11,000,
so your nominal capital gain was $1000 (10%).
Suppose = 10% in 2001. Your real capital gain is $0.
But the govt requires you to pay taxes on your $1000 nominal gain!!
slide 34
The costs of expected inflation: The costs of expected inflation: 44.. General inconvenienceGeneral inconvenience
Inflation makes it harder to compare nominal values from different time periods.
This complicates long-range financial planning.
slide 35
Additional cost of Additional cost of unexpectedunexpected inflation: inflation: arbitrary redistributions of purchasing powerarbitrary redistributions of purchasing power
Many long-term contracts not indexed, but based on e.
If turns out different from e, then some gain at others’ expense.
Example: borrowers & lenders
• If > e, then (r ) < (r e) and purchasing power is transferred from lenders to borrowers.
• If < e, then purchasing power is transferred from borrowers to lenders.
slide 36
Additional cost of high inflation: Additional cost of high inflation: increased uncertaintyincreased uncertainty
When inflation is high, it’s more variable and unpredictable: turns out different from e more often, and the differences tend to be larger (though not systematically positive or negative)
Arbitrary redistributions of wealth become more likely.
This creates higher uncertainty, which makes risk averse people worse off.
slide 37
Recent episodes of hyperinflation Recent episodes of hyperinflation
slide 38
slide 39
slide 40
Business CyclesBusiness Cycles
Business Cycles
–Business cycles are 2-year to 5-year fluctuations around trends in real GDP and other related variables
–A recession is a large fall in the growth of real GDP and related variables
•A depression is an especially large recession
slide 41
Business CyclesBusiness Cycles
slide 42
Real GDP Growth in the United StatesReal GDP Growth in the United States
-4
-2
0
2
4
6
8
10
1960 1965 1970 1975 1980 1985 1990 1995 2000
Percent change from 4 quarters
earlierAverage growth
rate = 3.5%
slide 43
Recessions in the U.S. since World War IIRecessions in the U.S. since World War II
Year and quarter of peak in RGDP
Number of quarters until trough in RGDP
Change in RGDP, peak to trough (%)
1948:4
1953:2
1957:3
1960:1
1970:3
1973:4
1980:1
1981:3
1990:2
2
3
2
3
1
5
2
4
3
-1.7
-2.7
-3.7
-1.6
-1.1
-3.4
-2.2
-2.9
-1.5
No simple regular or cyclical pattern: output changes very considerably in size and spacing
slide 44
Behavior of the Components of Behavior of the Components of Output in RecessionsOutput in Recessions
Component of GDP
Average Share in GDP (%)
Average Share in fall in GDP in recessions relative to normal growth (%)
Consumption Durables Nondurables Services
Investment Residential Business Fixed Inventories
Net Export
Gov’t Purchases
8.425.829.5
4.710.70.7
-0.4
20.6
15.611.29.1
20.911.740.6
-12.3
3.3
Fluctuations are distributed very unevenly over the components of output
slide 45
Cyclical Behavior of Cyclical Behavior of Key Macroeconomic VariablesKey Macroeconomic Variables
Procyclical variable
– An economic variable that moves in the “same” direction as aggregate economic activity
industrial production, consumption, investment, employment, real wage, inflation, stock prices
Countercyclical variable
– An economic variable that moves in the “opposite” direction as aggregate economic activity
unemployment
slide 46
Supply shocksSupply shocks
A supply shock alters production costs, affects the prices that firms charge. (also called price shocks)
Examples of adverse supply shocks: Bad weather reduces crop yields, pushing up
food prices. Workers unionize, negotiate wage increases. New environmental regulations require firms
to reduce emissions. Firms charge higher prices to help cover the costs of compliance.
(Favorable supply shocks lower costs and prices.)
slide 47
CASE STUDY: CASE STUDY: The 1970s oil shocksThe 1970s oil shocks
Early 1970s: OPEC coordinates a reduction in the supply of oil.
Oil prices rose11% in 1973 68% in 1974 16% in 1975
Such sharp oil price increases are supply shocks because they significantly impact production costs and prices.
slide 48
1P SRAS1
Y
P
AD
LRAS
YY2
The oil price shock shifts SRAS up, causing output and employment to fall.
A
BIn absence of further price shocks, prices will fall over time and economy moves back toward full employment.
2P SRAS2
CASE STUDY: CASE STUDY: The 1970s oil shocksThe 1970s oil shocks
A
slide 49
CASE STUDY: CASE STUDY: The 1970s oil shocksThe 1970s oil shocks
Predicted effects of the oil price shock:• inflation • output • unemployment
…and then a gradual recovery.
0%
10%
20%
30%
40%
50%
60%
70%
1973 1974 1975 1976 1977
4%
6%
8%
10%
12%
Change in oil prices (left scale)
Inflation rate-CPI (right scale)
Unemployment rate (right scale)
slide 50
CASE STUDY: CASE STUDY: The 1970s oil shocksThe 1970s oil shocks
Late 1970s:
As economy was recovering, oil prices shot up again, causing another huge supply shock!!!
0%
10%
20%
30%
40%
50%
60%
1977 1978 1979 1980 1981
4%
6%
8%
10%
12%
14%
Change in oil prices (left scale)
Inflation rate-CPI (right scale)
Unemployment rate (right scale)
slide 51
CASE STUDY: CASE STUDY: The 1980s oil shocksThe 1980s oil shocks
1980s: A favorable supply shock--a significant fall in oil prices.
As the model would predict, inflation and unemployment fell:
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
1982 1983 1984 1985 1986 1987
0%
2%
4%
6%
8%
10%
Change in oil prices (left scale)
Inflation rate-CPI (right scale)
Unemployment rate (right scale)
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