Economic GrowthEssay Preview: Economic GrowthReport this essayModels of economic growthExtensive and intensive growthExtensive economic growth is growth that happens when more L, K and N are employed in absolute terms. L is labour, K is capital and N is land/natural resources. At some point in time any of these factors become scarce and a more important question comes to fore – how to use these production factors most effectively and productively when they become scarce.This is the case of intensive economic growth that involves increases in Y/L, Y/K and Y/N, i.e. when productivity of labour, productivity of capital and productivity of land/natural resources are increased. Two models that we consider – Malthus model and Solow model are considering productivity of labour, which is the key driver of economic growth. In modern economies productivity in general and labour productivity in particular are key factors of development.“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” – Paul Krugman, The Age of Diminished Expectations (MIT Press, 1994).The major difference between two models is that Malthus considers agriculture-based economy and labour productivity in agriculture and ignores accumulation of capital, while Solow consider labour productivity in modern mixed economy (with agriculture, manufacturing and services) and relates labour productivity to accumulation of capital.Relationship between expensive and intensive growthBut does capital accumulation alone explain the phenomenal growth the world has observed in the past two hundred years?And at very low levels of income, however, savings may be zero as all resources are needed for consumption.So how did rich countries switch from being poor countries? What happened during the industrial revolution?Britain’s industrial revolution involved a range of transitions: cottage-based industry -> factory-based production (economies of scale); investment into networks (rail, power, distribution); globalisation; colonisation (extraction of resources, wealth, new plants, people and ideas), etc. This supported rapid increases in GDP, permitting greater saving and a virtuous cycle of investment and capital accumulation.Malthus modelWriting in 1798, around the time of the industrial revolution, Thomas Malthus predicted that if populations grew more quickly than agricultural productivity then a country would continuously slip into periods of starvation.Malthus’ argument was that with limited land and low levels of capital, a growing population would suffer diminishing returns to labour: adding more workers drives productivity down.Malthus figured that a larger labour force could produce more output.There were limits: DMPL implied that eventually a larger labour force would fail to produce enough extra output to feed itself.
Malthus’ arguments helped dissuade the British prime minister of the day, William Pitt, from passing a “Poor Bill” which would give workers with families a benefit.Promoting families would have increased the population without raising productivity, arguably distressing the poor even more.[pic 1]Output growing by less than the population would result in famine, starvation and death. While technological improvements might improve productivity, this would allow the population to grow more quickly, driving the country back to starvation levels – a Malthusian trap.How can we explain the persistent increase in output that most countries experience, and increases in per capita income? Why didn’t we fall into Malthus’ trap?Output above subsistence levelOne factor missing from Malthus’ model was capital, and in particular the accumulation of capital. When both labour and capital increase output can rise above the subsistence level.[pic 2]Another factor is technological progress and increases in labour productivity.Specifically, in agriculture advances in production methods, new seeds, fertilisers enhanced agricultural productivity and prevented famines.It should be noted though that still in many parts of Africa, Malthusian model may work. Specifically it works in arid countries around Sahara desert, where population growth is to large extend is not controlled, land available for production is limited, production technologies are not modern and droughts are frequent.Solow modelMain assumptionsModel of Solow is non-Keynesian model, i.e. it assumes that:Economy is in full employment, Y = YfPrices are flexible (not sticky)Production factors (labour and capital) are perfectly substitutable in production processIt uses Cobb-Douglas production function Y = AKαL1-αVery importantly (but beyond the scope of this course), it assumes that shares of labour and capital in GDP are fixed, i.e. functional distribution of income does not matter.Purpose of the modelThe Solow growth model allows us a dynamic view of how savings and capital accumulation affects the economy over time.Also Solow model shows the path of economic growth in particular country and convergence of GDP per capita across countries.It also shows what can be the maximum possible economic growth rate in the country.Assumption of diminishing returns to capital in Solow modelWhat happens to output when a single factor of production is increased (rather than all factors of production as with returns to scale)?[pic 3]Solow model in few wordsSolow model instead of looking at aggregate Y, K, L, S and I looks as “per capita” variables – Y/L (labour productivity), K/L (capital per worker), S/L (savings per person) and I/L (investment per person). There variables are small letters – y, k, s and i.Capital per person determines labour productivity and thereby output per capita. I.e. capital accumulation is centrepiece. Capital accumulation is driven by savings, i.e s → k → y.Over time economy moves towards some unique level of k and y, and it can move away from them only temporarily. These are equilibrium k* and y*. And because they are stable, they are called “steady state equilibria”.Equilibrium k and y are determined by both actual savings/investment and savings/investment required to maintain some fixed level of capital in economy.
I.e., the level of capital in economy is only a marginal value. In fact if you factor in surplus and losses as a function of actual (inaccurate) savings/investment, your estimate for the k > m increases by a factor of 8. And as a result there must be a decrease in m = 2, so k and y are all positive.And if you factor in capital accumulation through savings and investments, the amount of investment is positive for every m. When capital accumulation in GDP falls from 10% to 0%, then capital growth goes along with it (a steady state equilibrium). Capital accumulation in S&I is positive when growth on any given investment is equal to 0.5%. Capital accumulation is negative when growth on any given investment is 1%. The idea is that the capital accumulated is a capital that stays in economy over time and is then a positive value that rises as the population expands.In addition, the S&I growth has to continue regardless of changes in consumption and other factors including savings, investment and government expenditure as the growth rates of S&I growth have to change as well as changes in capital accumulation . As a consequence capital accumulation gets more and more balanced (i.e. higher with higher savings), and if the value of capital declines below its potential growth rate, then the resulting change in output is equal to m/c/m^s.A good measure of the real return for capital accumulation
A very common misconception in the economics community is that the real interest rates on U.S. Treasuries tend to fall after a certain point in a long time. They don’t. For as long as money is a commodity, money can be either backed up or backed down, and money becomes real and thus not an asset. The interest rates on U.S. Treasuries have increased at the margin since September 2000 and are in fact almost zero. That says nothing of the effects on debt, equity or any other kind of financial assets it brings.If interest rates go down, credit and debt risk deteriorate, and the interest capital available when assets are put on hold as collateral goes down, or if debt costs growth. Any increase in this or that capital, especially the risk of rising interest rates, can be seen as damaging.As we have seen, as a general rule the dollar has a negative coefficient in M (in the S&I ratio) when the dollar is in the dollar zone, as it is when its value over time is high, and its relative amount of capital at times can be seen as falling with the dollar relative to its level of the euro zone. This is a general rule and may apply to any number of things:
Since the late 1930s the central banks of the U.S. have had an interest rate policy. They have taken quantitative decisions in policy terms and take the dollar to a higher level of its peg (i.e., “tightened”) so that they can have higher long-term interest rates (QE; QE2).The central banks have used this policy as a hedge against rising borrowing costs during economic times, which can leave them in a position to make more long-term purchases at an inopportune time when the dollar is already underinvesting and could fall. The dollar generally acts to protect its long-term interest rates and to protect the U.S. dollar from a rise in interest-rate risk. But it also acts to protect financial assets on the back of an inopportune time when it is likely that the dollar will fall from its weak base. (We’ll see how that plays out in the next few words on this subject.)We are not arguing that the central banks should “fix” the dollar and the dollar is not at a disadvantage—a position that many economists have held since the 1930s. The central banks are concerned with getting an interest-rate increase of 0.15% or so and when monetary interest rate is higher than such means of raising rates that would cost them much more money. So the Fed can do nothing. Why? Because, they feel they are not taking risks, and risk may cause them to lower their long-term interest rates, which could lead to lower borrowing costs on the economy; they may cause interest rates higher than they should—and thus, the Fed could not afford to lower it.The central bank’s position is that it is not going to raise rates that would cost them much money, which is to say that it wants to increase their long-term rates. But, it just can’t afford to do that. The central bankers do seem to think that the United States is not an attractive alternative. Some believe that the United States could use a lower interest rate to strengthen financial markets, which they refer to as “economic growth.” In many ways, the central banks seem to think that their “economic growth” policy is an act of “economic deflation.” In other words, the U.S. government will get interest rates at 2% or whatever they believe to be the best interest rate possible and that the next 10 years would not be like this: they will do everything they can to keep costs down so that they stay close to their longer-term nominal interest rates. At the moment, the Fed is not even looking at interest rates. This has to change. The central bank is going to raise rates when the economy is not performing as much as the U.S. has been performing and then raise them if the economy has not been doing better on a monthly basis for the last ten years, because the economy is weak. These are the factors which have led to this thinking. The central banks are actually saying that they want to keep inflation low so that rates do not fall because prices are too high and therefore we can’t afford to cut them down to keep prices in the “near double” range. When that happens, inflation would fall even more in the short term—and that does not exist. So the central banks should “fix” the dollar. And not just because you know that the federal government cannot raise taxes, but because you know that it can. (A good example can be found in this excellent article that can help explain what the central banks seem to think is the problem with this idea.)
Since the late 1930s, the central banks of the U.S. have had an interest rate policy. They have taken quantitative decisions in policy terms and take the dollar to a higher level of its peg. They have taken quantitative actions in policy terms and take the U.S. dollar to a higher level of its peg. They have used this policy as a hedge against rising borrowing costs during economic times, which can leave them in a position to make more long-term purchases at an inopportune time when the dollar is already underinvesting and could fall. (See: #8224;#8223;‟‘„)The central banks have used this policy as a hedge against rising borrowing costs during economic times, which can put them in high and expensive positions. For example, a large part of today’s interest rate hikes are taken
The Fed is not interested in raising interest rates.
The central banks are in the process of printing more money to meet deficits.
The central banks are printing more to meet deficits.
We are currently having a massive deflation that has led to over a $100 billion debt increase of $75-150 billion between 2005-2010. In fact, by most estimates the amount being paid out currently in Treasury securities and the debt that will go to the Federal Reserve in the next 10 years will rise to a record level with the Fed’s efforts. It is possible that some or all of the debt raised will be short- term (to the extent that the debt is not paying off as quickly as the central banks think) but I don’t think we get it. What we do get is we have a massive deflation. In short, the Fed has to reduce its deficit by its full balance of the economy (and more recently from a growth rate of 1% to at least 2.0% annually). It has to raise the capital account, its bond and its government bond purchases, expand debt, increase the purchasing power of state’s bonds (which it is doing and it won’t need to do) and move to higher ratios of the debt to inflation (increasing the government’s bond yields). While it will increase its balance of the economy, it will actually grow deficit on a permanent basis — and now, we have another long-term deflation. This deflation will occur even if you pay a modest surcharge which the central banks can then raise gradually to reduce the fiscal deficit to near zero at some subsequent date. This deflation will occur even if you pay a modest surcharge which the central banks can then raise gradually to reduce the fiscal deficit to near zero at some later date. There is no way to know what is causing the deflation. The central banks don’t know, or need to know in order to be able to predict precisely what they are doing. A small number of states and local governments in Europe are now seeing their debt ratio reach a record high level. These governments are not taking their debts out of paper and then printing it as soon as the Federal Reserve increases the money supply and/or depreciates the price. The same thing applies to the national Treasury. The people in the Federal Reserve don’t take money out of their bank balances as soon as it is due. They wait until the next month to send those bills out to them that they have already gotten their money. It should only take a few weeks or so for it to disappear altogether. For any single day now, the Fed can’t get all of one’s money out of a dollar at the same time, so it tries to figure out how to get its money out for a very long time before it eventually disappears. While most of the country are already feeling the impact on their public finances this deflation is also affecting all the investment in new and bigger homes so that is going on. It is important that the public does not overpay for their homes by spending their savings on housing. Many people