Learning About Growth
We introduce a model in which a consumers must learn whether a country's growth rate shock is permanent or transitory. We show that for developing countries, TFP growth rates have been highly volatile, while for developed country the growth rate is comparatively stable. This difference is sufficient to explain the allocation puzzle under the assumption that the initial correlation between forecasted and realized growth rates is negative. In addition, we document that the allocation puzzle puzzle decreases over time - the ten year correlation between inflows and growth rates is more negative than the twenty year correlation - in agreement with our model predictions. We interpret this as evidence that the learning mechanism underlying our model is relevant to understanding the differences in behavior of developed and developing countries.
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