Notes1_2008

# Notes1_2008 - Disclaimer These notes were prepared based on...

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Disclaimer: These notes were prepared based on lectures of Prof-Sala-Martin’s 2008 Fall Course of Intermediate Macro-W3213. Contents of these notes might not match completely with the current teachings in class. An updated version would be available later in the semester. (1) The Importance of Growth Theory. Growth theory is the hardest part of macroeconomics so we need to be patient. If we look at the economy 100 years ago and look today we see that annual growth rates of 2% versus growth of 3% or 1% can make big differences in the economy’s outcome in terms of per capita income. Fig 1.1 For example in 1995, US per capita income was close to \$27,000 dollars and it was the richest country in the world. Whereas the poorest country was Ethiopia with \$400 per capita income : thus Ethiopia was 58 times poorer than US!!! The question arises: Why? U.S. income in 1870 was \$2244 (i.e. it got multiplied by 8 in 100 years) and the growth rate (γ) was close to 1.75% per year. If instead γ had been 0.75, per capita income (y) would have been \$5500 in 1995!!! (like Mexico or Hungary, 1000 less than Portugal or Greece). On the other hand if γ had been 2.75 percent, then y in 1995 would be \$60000. No country in history has had this income yet. Thus we see that growth is really important and one percentage point difference in growth rate can make a lot of difference in the long term outcome. Fig 1.1 shows how GDP per capita would evolve for different growth rates γ. Hypothetical GDP Paths 7 8 9 10 11 12 1870 1890 1910 1930 1950 1970 1990 2010 year log (GDP per capita Growth 2% Growth 1% Growth 3%

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Fig 1.2 Some growth trends over the last few decades Table 1.1 a) Asian countries (China, India) are growing very fast (7-10 %) and in these countries poverty rate is declining. b) Africa has very low growth rate (2-3% in 2005) and around 40% of the population in Africa is below the poverty line (\$1/ day). Africa needs to double its growth rate to cut poverty levels by half. More disturbing is that the number of poor people in Africa has increased over the last few years (only place where this has happened). c) Latin America has sort of stagnated. Clearly the implications of growth for welfare are enormous: Do you want to be US or do you want to be Africa? Next to the enormity of this, the business cycle (the short run fluctuation of macroeconomic variables) seems to be a minor problem that we do not need to worry about (Not really though!). However, economists neglected growth for many years: Neoclassical theory was created in the
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