Academic journal article Economic Inquiry

Characterizing Economic Growth Paths Based on New Structural Change Tests

Academic journal article Economic Inquiry

Characterizing Economic Growth Paths Based on New Structural Change Tests

Article excerpt

I. INTRODUCTION

Determining the nature of the trend in per capita output, that is, whether it is deterministic or stochastic, and whether structural breaks are present, has been extensively debated in the literature. These two important and interrelated features have very important macroeconomic and econometric implications.

On the one hand, as put forward by Nelson and Plosser (1982), if per capita output has a unit root, implying a stochastic trend, then real shocks are likely to be the most important source of macroeconomic fluctuations as opposed to disturbances with only a transitory impact (such as monetary and other demand-side shocks), being consistent with the real business cycle theory. Conversely, if the trend in per capita output is deterministic then one should observe only short-run fluctuations primarily determined by demand shocks with a transitory impact (in such cases, monetary shocks explain a large fraction of business cycle fluctuations). Moreover, the interpretation and usefulness of linear regression models involving the output variable critically depend on the nature of the trend, as ordinary least squares (OLS) may produce spurious results in the presence of a stochastic trend (Granger and Newbold 1974; Phillips 1986).

On the other hand, studying the stability of the output growth rate is an important topic for the debate between neoclassical, semi-endogenous, and endogenous growth theories for the model that best describes what we observe in the data. Jones (1995a, 2002, 2005) contrasted the substantial and permanent rise of investment in human capital and research and development (R&D) with the remarkable stability of U.S. per capita output. On the basis of these models we should have observed permanent positive shifts in the rate of economic growth according to the endogenous growth literature or, at least, short-run increases and long-run "level effects" according to the neoclassical and semi-endogenous growth models. However, the growth rate of U.S. per capita output has been remarkably stable since the end of the nineteenth century. Moreover, Jones (1995b) documents that in Organization for Economic Co-operation and Development economies since World War II several variables that should lead to permanent changes in the long-run growth rate or, at least, originate "level effects," exhibited large and persistent movements, generally in the "growth-increasing" direction. On the basis of the documented increase of these variables, Papell and Prodan (2005) classified several countries according to three mutually exclusive hypotheses, each compatible with a certain class of economic growth models:

(a) The "Summer-Weil-Jones" or "constant trend" hypothesis, originally suggested by David Weil and Lawrence Summers and subsequently considered in Jones (1995b), postulates that a simple time trend with slope equal to the average growth rate should describe the log of per capita output accurately. Some temporary departures from the trend are allowed, corresponding to large exogenous shocks to the economy and its subsequent recovery, but the linear trend should return to its original path.

(b) The "Jones-Solow" or "level shift" hypothesis favors the neoclassical Solow (1956) and the Jones' (1995a, 2005) semi-endogenous growth theories. It states that, after policy changes (such as a rise in human capital or R&D investment), output growth may change in the short run but should return to its original value in the long run. However, these changes should lead to long-run increases in the level of per capita gross domestic product (GDP).

(c) The "Romer" or "slope shift" hypothesis postulated by Romer (1986) suggests that policy changes should alter the growth rate of per capita output permanently.

Considering the hypotheses previously indicated (i.e., the "constant trend," the "level shift," and the "slope shift" hypotheses), the objective of this article is to analyze which of these better characterizes the growth path of per capita output. …

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