The Speed of Adjustment in Growth Models

Abstract

Until now, the focus of our analysis has been on the existence of the balanced growth path and its properties. However, it is of considerable interest to consider the question: How long will it take an economic system to reach a balanced growth path? For example, suppose that a given economy is already in long run equilibrium growth. Now let the government increase the overall saving rate by appropriate fiscal measures. We know that (see exercise 3.1) the effect of this is to raise the growth rate initially but eventually the growth rate will move back to the natural rate. How long will it take to achieve nearly complete adjustment, if the values of the parameters of the system are known? What are the policy implications of the length of the adjustment period? If the adjustment period is very long, then an increase in the growth rate resulting from a higher saving rate will continue for a long time. On the other hand, if the fiscal policy goal is to raise the equilibrium level of per capita income, a small adjustment time is more desirable. If the model adjusts to equilibrium faster than the parameters are likely to change, then there is a strong justification for assuming the parameters to be constant. If adjustment is slow, the limiting behavior of the model is not very relevant because the values of the parameters would have changed in the interim period. It is therefore essential to know the adjustment time for a given model of economic growth. In this chapter, we take a broad spectrum of growth models and compare their speeds of adjustment.