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The Transitional Dynamics of Fiscal Policy: Long-run Capital Accumulation and Growth

  • Stephen Turnovsky

Recent research in growth theory has established the importance of the non-scale growth model, a key advantage of which is that they are consistent with balanced growth under quite general production structures. Indeed, if the knife-edge restriction that generates traditional endogenous growth models is not imposed, then any stable balanced growth equilibrium is characterized by the absence of scale effects. In this case the long-run equilibrium growth rate is determined by technological parameters and is independent of macro policy instruments.Despite the fact that the equilibrium growth rate is independent of macro policy, fiscal policy remains an important determinant of long-run economic performance. First, fiscal policy has significant effects on the levels of key economic variables, such as the per capita stock of capital and output. Moreover, the non-scale model typically yields slow asymptotic speeds of convergence, consistent with the empirical evidence of 2-3% per annum. This implies that policy changes can affect growth rates for sustained periods of time, so that the accumulated effects of policy changes during the transition from one equilibrium to another may therefore translate to potentially large impacts on steady-state levels. Thus, although the stock of capital grows at the same rates across steady states, the corresponding bases upon which the growth rates compound may be substantially different.These considerations suggest that attention should be directed to determining the impact of fiscal policy on the transitional dynamics. This is the focus of the present paper. The model we employ is of a one-sector economy in which output depends upon the stocks of both private and public capital, as well as endogenously supplied labor. Public capital introduces a positive externality in production, so that the complete production function is one of overall increasing returns to scale in these three productive factors. In addition to accumulating public c

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Paper provided by Department of Economics at the University of Washington in its series Discussion Papers in Economics at the University of Washington with number 0018.

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Date of creation: Apr 2000
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Handle: RePEc:fth:washer:0018
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