almaty 2011
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Economic Policy Consistency and the Growth of Nations
Finn E. Kydland University of California
Santa Barbara
Almaty, May 5-6, 2011
Real GDP per capita Real GDP per capita
Real GDP per capita Real GDP per capita
Real GDP per capita Real GDP per capita
• All interesting macroeconomic phenomena are forward-looking (dynamic)
Aggregate production function
GDPt = ZtF(Kt,Lt)
Technology for converting inputs of capitaland labour into output of goods and services
Technological progress
• Recent examples of U.S. government “policy” (theme: significant stimulus for the economy?)
Fiscal policy: Stimulus through temporary tax rebates – little effect on consumer spending (and investment)
Stimulus spending? Investment in infrastructure, if it improves future productivity significantly, can justify the additional debt to pay for it. Otherwise, may be a bad idea, especially for a nation with budget problems.
• Monetary policy
Monetary changes ordinarily not potentto stimulate the economy
What about the big U.S. central-bank injection of liquidity in 2008? Needed in order to counteract major decline in money multiplier
• Money multiplier
Quantity of money = Money multiplier x Monetary base
Money multiplier affected negatively by rise in reserve/deposit ratio and in currency/deposit ratio
Injection of liquidity (base money) not inflationary unless it more than makes up for drop in multiplier.But what about the next few years?
• Perspective from a bit of theory of benign government:
Suppose the government has an unchanging objective, say, to maximize some measure of the present value of citizens’ welfare over time
Theoretical result: The resulting optimal government policy generally is inconsistent over time; it requires a commitment mechanism in order to be implemented. Otherwise, there’s a strong temptation to change policy in the future.
• Where is that temptation theoretically the greatest?
Increase tax on physical and human capital(especially relevant in the current situationwith large and growing debt/GDP ratios)
Partially renege (default) on government debt, say, through surprise inflation
Examples of mechanisms used in practice by governments to tie their own hands (not always successfully!)
(i) Gold Standard
(ii) Currency Board
(iii) Independent Central Banks
• Main driving forces for economic growth:
Innovation and technological progress(Z in the production function).
Future productivity growth is key.
• But, to take advantage of technological change:
Need incentives to invest in new capital, physical (structures and equipment) and human Government policy may be a crucial factor, positive or negative, for growth
Examples: Argentina in 1990s and early 2000s (negative)Ireland in 1990s and much of 2000s (positive)
ARGENTINAGDP per working age person (Index)
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1
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Ln
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DP
p.
c.)
1998
Lost Decade Depression
1990s boom
• Argentina experienced Lost Decade in the 1980s. But especially interesting: The 1990s boom
Economy grew at quite high rates in the 1990sSurprise: In light of the observed rate of productivity growth, a standard macro model implies that investment should have been much larger in the 1990s, and the capital stock therefore much greater by the end of the decade
ARGENTINAGDP
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Ln
(G
DP
)
Data
ARGENTINAGDP
-0.4
-0.3
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-0.1
0
0.1
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Ln
(G
DP
)
Data
Model
ARGENTINACapital Input
0.3
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Ln
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Data
ARGENTINACapital Input
0.3
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1
19
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Model
Data
Model
• Probable main explanation
Time-inconsistency “disease” due topast hyperinflations, devaluations,deposit freezes and defaults ongovernment obligations, resulting inlack of credibility among investors
ARGENTINACapital input per working age person
LOWER CAPITAL: LOWER REAL WAGES, WORSE DISTRIBUTION OF INCOME
0.1
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Data
• Contrast with Ireland
Strong growth since 1990
But first: Schooling had expanded since 1960s
Then, around 1990:Introduced tax policy geared for the long-run
Lower tax rates, with commitmentfor the next 20 years
• Examples of productivity-enhancing policies vs lack thereof
Chile and Mexico after 1981
Finland and Japan after 1990
Korea 1997-98
• Summary of lessons for policy
Focus on incentives for productivitygrowth (innovation) and capitalaccumulation
Government policy has to be credible and forward-looking
Ideally, need institutions geared to avoiding “time-inconsistency disease”
• Income and wealth disparities across nations
Low income often the result of country-specific policies that directly or indirectly restrict the setof technologies and work practices that can be used
Bad: protection of vested interests
A lot of knowledge available. May need to be combined with nation-specific innovative activity
• Importance of good economic policy
Paraphrasing the conclusion of Parente & Prescott’sbook on Barriers to Riches:
With good policy, there is potential in poor nationsfor, not 1-2 percent, but 1000-2000 percent income increase
Ex.: Korea’s growth miracle, from 1965 to 1990for example, represented a 6-fold increase in per capita output
• Main Conclusions
Designing policy for the Longer Run much more important than short run
Enough uncertainty in the world as is;extra government uncertainty is bad
Opportunity for nations with credibility to narrow gap to the high-income-per-capita countries
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