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On the Stability of the Two-Sector Neoclassical Growth Model with Externalities

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Author Info
Berthold Herrendorf () (W. P. Carey School of Business Department of Economics)
Akos Valentinyi (University of Southampton)
Abstract

We study a class of two-sector neoclassical growth models, in which one sector produces consumption goods and the other sector produces the capital goods for both sectors and in which the capital-producing sector has sector-specific externalities. We show analytically that if the capital goods for the two sectors are imperfect substitutes, then local indeterminacy near the steady state is impossible for every empirically plausible specification of the model parameters. More specifically, we show that a necessary condition for local indeterminacy is an upward-sloping aggregate labor demand curve in the capital sector, which requires a counterfactual strength of the externality. We show numerically that an elasticity of substitution of plausible size implies determinacy near the steady state for all empirically plausible specifications of the model parameters. These findings differ sharply from the standard result that if the two capital goods are perfect substitutes, then local indeterminacy occurs in the two-sector model for a wide range of plausible parameter values.

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Paper provided by Department of Economics, W. P. Carey School of Business, Arizona State University in its series Working Papers with number 2167721.

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  1. Herrendorf, Berthold & Valentinyi, Akos, 2002. "Determinacy Through Intertemporal Capital Adjustment Costs," CEPR Discussion Papers 3581, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  2. Berthold Herrendorf & Akos Valentinyi, 2003. "Determinacy Through Intertemporal Adjustment Costs," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 483-497, July. [Downloadable!] (restricted)
  3. repec:bep:maccon:v:5:y:2005:i:1:p:1251-1251 is not listed on IDEAS
  4. David R. Stockman, 2007. "Chaos and Sector-specific Externalities," Working Papers 07-17, University of Delaware, Department of Economics. [Downloadable!]
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