Saturday, February 21, 2009
Questions About Growth
Now, let’s see what implications this has on two relevant discussions about today’s economy. First, what happens if people are scared and start to save money? This will increase the savings rate, γ. If we assume a straight line depreciation, δ, of 10%, .10, an initial savings of .8 then y = 8. If savings increases, to .9, then y increases to 9. This simple derivation concludes that an increase in savings will INCREASE income per worker. In macro we discuss the paradox of thrift. Is it a paradox? Consumers are saving more fearing a long protracted recession. Are consumers really helping to build capital stock for future generations?
The next question I address is how to spend the stimulus. Returning to point 2, an increase in k will increase income per worker at a diminishing rate. Not obvious from the equation is that the economy will begin to accumulate capital and work toward a higher steady state. In other words, spending on infrastructure will provide more income and tools for long-run growth. Does this sound Keynesian?