Econ 2010c Final – Fall 2009 – Robert Barro’s part

I. (32 minutes, 8 minutes each).

True/False/Uncertain. Explain briefly. Explanation determines grade.

1. To fit the observed equity premium, the neoclassical growth model (with shocks to the

production function) requires an unrealistically high coefficient of relative risk aversion.

2. In the (Paul) Romer-style endogenous growth model (varieties model), a decrease in

monopoly power lowers the growth rate of per capita GDP.

3. In the Blanchard-Weil “finite-horizon” version of the neoclassical growth model,

Ricardian Equivalence does not hold unless people live forever (p=0).

4. For a given behavior of government purchases, G, optimal taxation typically requires

a positive tax rate on real money balances (that is, a positive nominal interest rate).

II. (35 minutes).

Assume that output, Y, depends on physical capital, K, human capital, H, and raw labor,

L, through the production function:

Y = AKαHβL

1-α-β, where α>0, β>0, α+β<1.

Assume, as in the Solow model, that the gross saving rate, s, is an exogenous constant (0<s<1).

The depreciation rate for K and H is δ>0. Ignore population growth (n=0, L=constant) and

technological progress (x=0). Assume a one-sector production function, so that units of C and

new units of K and H can be transformed on a one-to-one basis from the output stream, Y.

1. Assume that the form of investment is reversible, in the sense that an old unit of H can

be converted on a one-to-one basis into a unit of K, and vice versa.

a. What condition determines the ratio K/H?

b. What is the steady-state growth rate of Y, K, and H?

c. Suppose that the economy starts at the steady state, but a (temporary) war then

destroys lots of K but no H. How does the economy behave after the war? Is the

growth rate of Y above the steady-state growth rate for awhile? Explain.

2. How are the results altered (qualitatively) if old units of H cannot be transformed into

units of K?

III. (23 minutes).

An empirical study for Swedish municipalities finds that a lower probability of reelection

for mayors (based on public-opinion polls) raises the fiscal deficit for right-wing governments

but lowers the fiscal deficit for left-wing governments.

1. How does this evidence relate to the strategic-debt model of Persson-Svensson (a

simplified version of which was discussed in class)? Does the empirical evidence support this

model? Discuss possible alternative explanations for the pattern found in the data.

2. Suppose that you have data separately for government spending, G, and taxes, T.

How would these extra data help in interpreting the evidence?