Crises and recovery in emerging markets: ‘Phoenix miracles’ or endogenous
growth?
Marcus Miller a,b and Lei Zhanga
a
b
University of Warwick and CSGR
Centre for Economic Policy Research, London
January 2007
Abstract
The Great Depression of the 1930s gave birth to Keynesian economics with its focus
on aggregate demand. In recent crises in emerging markets, currency devaluation and
associated balance sheet effects have played a key role. Does this call for a new
paradigm? After a comprehensive survey of many crisis episodes - including the US
Great Depression - Calvo and colleagues from IDB offer the paradigm of a ‘Phoenix
Miracle’. It is a static, supply-side account where factor productivity falls in recession
and rises promptly thereafter.
By contrast, we argue that the real miracle in East Asia is economic growth. This is
rudely interrupted by external shocks: but then it restarts at a lower level of trend
GDP. This we show in a simple model of endogenous growth, disturbed by shocks to
supply and demand. Heterogeneity of production implies that both are relevant - as in
New-Keynesian paradigm for monetary policy proposed by Stiglitz and Greenwald,
where monetary contraction affects both supply ( of traded goods) and demand (for
non-traded goods).
1
Introduction
Financial crises in SE Asia sharply interrupted stellar economic progress in the
region: for a year economic growth went into reverse. It did not take long for growth
to resume, but output has followed a lower trend path. What happened, and why?
That these events were triggered by external capital market shocks is now widely
accepted; in the terminology developed at the IADB1, events in SE Asia followed
upon a Systemic Sudden Stop in capital flows. Liability dollarisation and the balance
sheet effects that accompanied currency devaluation undoubtedly played a key role in
depressing investment and supply, as did the high interest rates used to defend the
currencies. There is, so to say, agreement on the importance of the Fisher effect2, a
central element of so-called third generation models of crisis.
But how to explain the sharp falls of output that were almost synchronous with the
devaluation - and prompt recovery thereafter? Here there are sharp differences of
view. Some argue that the conventional stimulative effect of devaluation in the
Mundell-Fleming model of a small open economy must have been offset by the
(temporary) adverse demand effects of liability-dollarisation characteristic of
emerging markets.
After a comprehensive overview of crises in SE Asia and elsewhere, particularly in
Latin America, Guillermo Calvo and colleagues at the IADB have arrived at a
different conclusion. The fall of output was attributable to adverse supply-side effects
sharply lowering total factor productivity, and its prompt reversal is what they call a
Phoenix miracle, CIT(2006). It is not a matter of remembering Keynes: it is
understanding how supply contracts in a financial crisis.
To capture the setting of ongoing growth in SE Asia, we first examine these issues in
the framework of a simple model of endogenous growth. In this context, the Fisher
effect certainly interrupts growth but does not in itself cause a sharp fall in output. A
temporary fall in TFP will cut output, of course: but so too does a temporary fall of
1
Jeffrey Sachs said at the time that the SE Asia crisis was like a bank run.
So-called by Calvo et al. (2006) after Irving Fisher who emphasized the role of liability effects in the
US Great Depression.
2
2
output below existing capacity. The endogenous growth model used is of a closed
economy, but the arguments go through in a model of a small open economy with a
Fisher effect, as shown in the following section using the popular 3G model of ABB.
Shocks to demand and supply may be may be observationally equivalent at an
aggregate level, but not when account is taken of the distinction between traded and
non-traded goods. Supply side effects will be more relevant for traded goods and
demand effects for non-traded, as in New-Keynesian paradigm for monetary policy
proposed by Stiglitz and Greenwald, where devaluation and tight money can restrict
aggregate demand and disrupt supply in the traded goods sector (where demand is not
a problem).
1. Literature review
The deterioration of corporate balance sheets is a key element, as is clear from socalled ‘third generation’ models of crisis. But the role of debt in triggering economic
contraction has a much longer pedigree: what Irving Fisher referred to as the ‘debt
deflation’ mechanism operating in the US Great Depression provides a telling
precedent. But there is a key difference. For Fisher balance sheets deteriorated as
falling prices raised the real value of nominal debt3: while in emerging markets it is
devaluation against the dollar that raises the local currency value of debt contracts
denominated in foreign currency4. In the Biblical terminology of Eichengreen and
Hausmann, the crushing impact of the Fisher effect on private enterprise in emerging
markets is a legacy of Original Sin. In Latin America, for example, the ‘fear of
floating’ described by Calvo and Reinhart (2002) may be attributed to such balance
sheet effects of devaluation and to the high interest rates implemented to check the
fall in the currency.
Keynesian models can be adapted to take account of the Fisher effect. In is analytical
afterthoughts on the Asian crises, for example, Krugman (1999) used a demand-side
account of a small open economy to argue that “a loss of confidence by foreign
3
Note that, when the US left the gold standard, President F.D. Roosevelt cancelled the Gold Clause in
public and private debt.
4
As a consequence, debt can increase in real terms even when domestic prices rise.
3
investors can be self-justifying, because capital flight leads to a plunge in the
currency, and the balance-sheet effects of this plunge lead to a collapse in domestic
investment.” In a much more detailed framework, Céspedes et al. (2003) show that for
a highly dollarised open economy, the asset price effects of devaluation can
overwhelm trade effects, leading to a contraction of aggregate demand.
In the “third generation” approach developed by Aghion, Bacchetta and Banerjee
(2000), however, it is supply-side effects that play a central role. In the first place, the
trigger for crisis is an unexpected idiosyncratic, permanent fall in productivity which
lowers expected future supply. In the absence of a corresponding contraction of future
money, the currency is expected to be weaker in future. Anticipation leads to prompt
and unexpected devaluation with adverse balance sheet effects on investment further
reduce future supply. Current output is unaffected by the crisis, however.
Productivity effects also play a key role in account of Calvo et al (2006), hereafter
CIT, though here they are endogenous. The causal factor is a Sudden Stop which
leads to devaluation and a fall in productivity of currently installed plant and
equipment. “Sharp nominal (and real) currency devaluation in the presence of
Liability Dollarisation may have worked in Emerging Markets as a new version of
Fisher’s Debt Deflation syndrome, and may be central in explaining output
collapses.” CIT (2006p.10,11). How this might occur is explained by a partial
equilibrium model, where all output can be sold, but a sharp rise in the ex ante shortterm cost of borrowing not only reduces inventories and but also induces the firm to
sell physical capital5 to finance inventories: so firm output falls. Happily these effects
are temporary and productivity soon recovers without recourse to outside finance for
the firm: this is the Phoenix miracle.
[Picture of the U-shaped curve.]
In Towards a New Paradigm in Monetary Economics, p.264, Stiglitz and Greenwald
stress both the demand-side and supply-side effects of tight monetary policy at the
time of the crisis. In the case of Korea, for example, where interest rates were pushed
above 25% to try to stabilise the currency, they argue that:
5
Capital is apparently perfectly liquid as it can be sold at a fixed price with no transactions cost.
4
it was exporters’ failure to respond to the huge exchange rate reduction – which
should have stimulated demand - which makes it clear that the economy was not just
responding to a fall in aggregate demand. Such consequences were inevitable, unless
the producer could obtain cheaper credit elsewhere … or unless wage and price
adjustments were sufficiently large to compensate for the huge increase in capital
costs. In practice, even reductions in real wages of 20% or more did not suffice. Thus
monetary policy had the usual effect on aggregate demand (amplified by the adverse
effect of f increased bankruptcy probabilities on firm demand) … but they also had
huge effects on aggregate supply.
[More here…]
Views on the role of financial effects and the transmission mechanism are
summarised in the following Venn diagram. The papers just discussed appear in the
left circle as they ascribe a key causal role to the financial shocks (FS) – sharp
increases in net liabilities amplified by high interest rates used to defend the currency;
but they differ on the transmission mechanism whether they work through demand or
supply.
Figure 1 Financial shock, demand and supply
Supply
effects: SE
ABB(2000)
CIT(2006)
00 (2000)
Financial
effects: FS
GS(2003)
CCV(2003)
Krugman(1999)
Aggregate Demand
effects: DE
Obstfeld and
Rogoff(1996)
5
An interesting contrast is provided by the treatment of the small open economy in
Obstfeld and Rogoff (1996, Chapter 10.2), where the output of non-traded goods,
whose prices are fixed in the short run, varies with the exchange rate. Monetary
expansion leading to unanticipated devaluation has an unequivocally positive impact
on demand and production of these goods as they become cheaper than flex-price
traded goods. Maybe because it was written before the Asian crises, there is no role
for the balance sheet effects in this model.6
Much more emphasis here:
To analyse these issues without taking into account the ongoing economic growth in
the region; the miracle that CIT report is based on a static analysis
This is indicated briefly in the next section where the U shaped curve of CIT is shown
alongside with the long run growth.
East Asian countries may have suffered sharp, V-shaped recessions; but vigorous
growth resumed therafter. In the analysis that follows, a simple AK model of
endogenous growth is used to capture the ongoing process of rapid expansion and its
interruption due to the Fisher effect, be it mediated through reduction of demand or
supply.
6
Note that the eclectic approach of Cespedes et al.(2003) can deliver positive or
negative effects of devaluation on output, depending on the relative importance of
balance sheet considerations.
6
II. Phoenix miracle; or interrupted growth?
In CIT (2006), the stylized facts characterizing 3S output collapses are presented in a
series of fascinating graphs averaging data across affected countries. To illustrate,
Figure 1 reproduces the typical path of GDP so derived; and a matching index of the
capital stock.
Capital Stock
110
100
108
98
106
96
104
94
GDP
102
92
100
90
t-2
t-1
GDP Index
(LH scale)
t
t+1
t+2
Capital Stock Index
(RH scale)
“These episodes”, they observe, “are characterized by two salient features. First,
there is a dramatic collapse in output (…the average fall in GDP is 10 percent)
accompanied by a collapse in credit, but without any correspondingly sharp collapse
in either physical capital or the labor force. Second, recovery to pre-crisis output is
swift and “credit-less”… Thus, although a credit crunch appears to be central for
explaining output collapse, recovery can take place without credit. This remarkable
phenomenon that resembles the feat of the proverbial bird “rising from its ashes”
prompted us to call it Phoenix Miracle.”
7
A longer run perspective may be obtained by plotting GDP for some time before and
after the crisis. The longer run of data allows one to fit two trend paths, one before the
crisis and one after (with quarterly seasonal adjustment around the split trend), so as
to provide a crude estimate of potential GDP, of long run supply7.
130
S'
120
110
A ‘Phoenix Miracle’?
100
S
S'
90
80
70
S
60
Source: IMF:IFS. (Note: output volume is normalised to 100 in 2000; and the data seasonally adjusted by authors)
For the case of Korea shown in Figure 2, starting in the box showing data around the
time of the SE Asia crisis, one sees that GDP follows broadly the same trajectory
shown in the earlier figure. Looking outside the box, however, gives a new
perspective: though the trends fitted before and after have much the same slope, there
is a difference of about 10 percent in the level. From a growth perspective, therefore,
there appears to be a permanent loss of potential output. (Figures for Thailand and
Malaysia given in the Appendix show a similar pattern of a down-shift of trend
potential.)
7
Aghion and Banerjee () provide a similar graph for Indonesia.
8
In addition to the sharp fall in output summarised in Figure 1, there also appears to be
a down-shift in the trend path of output growth. As to why this might be so, the
behaviour of capital stock shown in Figure 1 provides a clue: on average
net capital formation effectively ceases during the crisis.8 In the next section we
sketch an endogenous growth model where a temporary dip in GDP leaves a
permanent mark on potential GDP.
The data for output in India shown in Figure 2 provide a striking contrast, with very
little evidence of the shock that shook its Eastern neighbours. According to
Williamson(), the main difference lay in the degree of capital market control
exercised there at the time: so the Indian experience offers support to the view of CIT
that the origins of the crisis lay in a Sudden Stop to capital markets.
III. Supply, Demand and Crises: an AK approach
As Fischer (2001) emphasises, financial crises in South-East Asia involved an initial
reversal of the growth rate, followed by prompt recovery: so output traces a V-shape
and as shown in Figure 2. These output effects can be explained in stylised fashion
using a simple AK model of endogenous growth incorporating balance sheet effects
and their impact on productivity and/or aggregate demand.
Let potential supply (Q) be determined by the capital stock (K) so
Q  AK
(1)
and net capital formation be defined as
K  I   K
(2)
8
The lack of external corporate finance in recovery is part of what CIT have described as a miracle.
The behaviour of real wages must surely be taken into account in this connexion, as a shift in factor
shares in favour of profits will increase the potential supply of internal funds for financing recovery.
While output falls by about 10% on average, CIT report that real wages fall by about a quarter in
emerging market crises: and from this there is, apparently, no recovery.
9
where  is the forward difference operator, and
 is the rate of exponential depreciation.
Gross investment depends on the flow of savings and the impact of balance sheet
effects, so
I  sQ   K
(3)
where s is the propensity to save and  K is an adverse balance sheet effect, a Fisher
effect.
In the absence of balance sheet effects, one obtains the canonical growth rate, namely:
Q K

 sA    gc
Q
K Canonical
(4)
endogenous
growth
rate
Phoenix Miracle
If an adverse balance sheet effect were simply to cut investment by βK for one
period, the growth of capital and output following the shock will simply fall by β, so
g
Q K

 sA      gc   ;
Q
K
(5)
but there will be no fall in output at the time of the shock. Adding a temporary fall in
productivity at the time of the shock, so Q  1    AK , will reduce savings so capital
will grow more slowly after the shock, specifically
K
 s 1    A      gc     sA
K
 gc     ( gc   )
(6)
Further, the fall of productivity means that output growth going into the recession will
be approximately
Q
 sA      gc  
Q
10
And there will be a sharp recovery coming out, namely
Q
 s 1    A       A  gc    s A   .
Q
Consider for example the case where the balance sheet effect just offsets canonical
growth, i.e.   ( sA   )   gc , but the productivity effect is twice as large, i.e.
  2 gc . In this case output growth will fall to –gc on entering into recession but
recovery will take place at almost twice the canonical rate. This is illustrate in Figure
6.
ln Q
ln Y
Loss of
Potential
Potential supply path without crisis
Supply with constant
productivity

Supply after productivity recovers
γ(gc+δ)
gc
time

0
1
2
Productivity recovers
Fall in productivity
Figure 6: Financial shock: short and long run effects on supply.
The impact of an adverse balance-sheet effect induced by currency devaluation at
period 1, assuming no productivity shock, means that output is not affected in period 1
but falls below the pre-existing trend by  % in all subsequent periods, as shown by
the upper solid line in the figure9. If the balance sheet effect triggers a fall in TFP so
9
Drawn on the convenient, but not essential, assumption that the balance sheet effect is sufficient to
wipe out the effects of one year’s growth, i.e. β = sA - δ.
11
that the growth rate of GDP changes sign (as was roughly the case for countries in SE
Asia), then the dip will lower potential supply yet further by the amount, γ(gc+δ) even
if productivity recovers promptly in period 2. With the productivity recession, the
lower bold line shows output exhibiting the familiar V-shape in the period of
devaluation, and recovering promptly thereafter (but to a lower trend) in period 2.
This satisfies the ouput pattern of a Phoenix miracle and the longer term downshift of
supply shown in Figure 2.
As Talvi (2006) indicates, a similar pattern may be observed in recent crises affecting
countries in Latin-America. Using Central-American GDP as proxy for the trend of
potential supply, he finds the characteristic V-shaped recession. Economic recovery,
accompanied by the redistribution of income in favour of profits but without external
credit, is fairly rapid; but it does not take output back to the previous trend.
Note, however, that much the same results follow if recession causes demand to fall
below supply.
Keynesian Recession
Loss of
Potential
ln Q
ln Y
Potential supply path without crisis

Supply
gc
time
0
A/s
1
2
Demand recovers
Figure 7: Financial
shock: effects on demand and supply:
Fall in demand
opening up a gap of
If there is demand falls so that income falls 5% as the economy moves into
recession as a result of an adverse balance sheet reducing investment by bK,.
12
As before an adverse balance sheet effect which cut investment by βK for one period
but left demand equal to capacity, would cut the growth of capacity by β for one
period as before, with no fall in output at the time of the shock (as consumption must
take up the slack). But what if demand Y falls beneath capacity Q as a result of the
shock to investment so an output gap opens such that Y  1    Q  (1   ) AK .
Assume that investment is otherwise unaffected but consumption falls by sbk.
For simplicity that consumption depends both on capacity output and on current
income, specifically
C= (1-s)Q - s(Q-Y) = Q -sY
So Y = C +I = Q-sY + sQ-bK =(1-s)Q –sY -bk
So (1-s)Y = (1-s)Q-bk
So Y=Q-bk/(1-s)
If we assume that bK is such that the effect on ouput is the same as it was in the
miracle case then the effect on output in the next period will be the same as well.
(Note that aggregate demand will fall by (1+s)bK =γQ, which implies that bK =is
γQ/(1+s) i.e. somewhat smaller than above, the reason being that the gap and the
investment fall have to satisfy a multiplier relation.) be approximately
Q
 sA      gc  
Q
And there will be a sharp recovery coming out, namely
Q
 s 1    A       A  gc    s A   .
Q
Do another with full multiplier
B Financial shocks in a small open economy
We leave longer run growth aspects to one side, to consider how financial shocks
might have both supply side and demand effects. In an open economy financial
restriction could, for example, could affect the supply of traded goods (for which
there is elastic demand), and the output of non-traded goods (where it is only local
demand that matters). These are the lines along which we interpret ABB(2000), a
popular model of monetary policy in a small open economy written to capture to the
exchange rate and balance sheet effects operating in East Asia.
Their analytical framework is used, subject to two changes inspired by the work of
Calvo and his colleagues at IDB. First the cause of the crisis is taken to be an external
financial shock (not an exogenous, domestic productivity shock). Second financial
conditions are assumed to impede the expansion of exports in the short run so that the
economy lacks the stabilising feature of unlimited foreign demand that assure full
employment of resources even in the short run. The results can be interpreted as the
effect of a Sudden Stop in capital flows; in an economy temporally deprived of an
automatic stabiliser.
13
Follows a short section which starts with credit crunch and has tight money causing a
deep crisis because exports don’t respond for supply side reasons. Compare this to
Greenwald and Stiglitz.
Conclusion
Not difficult to explain the downshift in trend path - not as a productivity shock but as
a result of lost investment.
Q K

 sA      s A
Q
K Canonical Balance Effect
endogenous
growth
rate
sheet
effect
( Fisher )
(6)
of
recession
( Keynes )
There are different views on how to explain the prompt fall in output. On the one side
there is the Standard Keynesian account which stresses the role of demand – what
Temin(1976) calls the ‘spending hypothesis’ (and to which he attributes the sharp
downturn in the US from 1929 to 1932). It is more plausible that production of
nontraded goods could be demand constrained than for traded goods. But, note that,
if the price of traded goods moves with the cost of foreign currency, the relative price
effect will tend to increase demand of non-traded goods, Obstfeld and Rogoff(1996).
So it will require falling incomes of consumers to reduce consumer demand, this
could come from a squeeze on real wages (a charactersitic of recent crises noted by
CIT), or as knock-on effect of the fall of investment demand, which will be hit
directly by the Fisher effect, as ABB point out.
By contrast, CIT discount the demand-side completely in favour of an inventorydriven account of a Phoenix miracle. Firms can sell anything they produce, but high
interest rates persuade them to economise on inventories and to sell capital. The
partial equilibrium account they offer is somewhat problematic as it requires that
physical capital is perfectly liquid in a recession and fails to explain why reduced
output in the firm selling capital is not largely offset by increased output from the
14
buyer. It takes no account of liability dollarisation, moreover, nor of how a substantial
shift in the distribution of income from wages to profits might help produce a
creditless recovery.
By contrast the New Keynesian approach taken by Stiglitz and Greenwald allows for
supply side effects on suppliers of traded goods, as well as aggregate demand effects
on the economy as a whole (mainly non traded, presumably). In addition the emphasis
on bankruptcy risk allows a direct role for the Fisher effect. The benefits of this
eclectic approach is that requires no miracle for output to recover: rising demand,
falling interest rates, banks getting back to business and receding threats of
bankruptcy will do.
References
Aghion, Philippe, Philippe Bacchetta and Abhijit Banerjee (2000), ‘A simple model
of monetary policy and currency crises’, European Economic Review 44(4-6), 728–
738.
Aghion, Philippe and Abhijit Banerjee (2005) Volatility and Growth.Clarendon
Lectures in Economics. Oxford: Oxford University Press
Calvo, Guillermo, Alejandro Izquierdo and Ernesto Talvi (2006) “Phoenix Miracles in
Emerging Markets: recovering without credit from systemic financial crisis” NBER
WP 12101, Cambridge, MA:
Céspedes, Luis, Roberto Chang and Andrés Velasco (2003), ‘IS-LM-BP in the
Pampas’, IMF Staff Papers 50(Special issue), 143–156.
Diamond(1982)
Luangaram, P (0
Miller, Fronti, Zhang(2006) EER paper CSGR version
Stiglitz, Joseph (2006) Making globalisation work,
Stiglitz, Joseph and Bruce Greenwald (2003) Towards a New Paradigm in Monetary
Economics. Cambridge,UK:Cambridge University Press
Temin Peter(1976) Did Monetary Forces Cause the Great Depression? New York:
Norton
Williamson, John (1999) ‘Implications
Phoenix Miracle
15
Average growth, g = 0.05
Productivity fall = 0.1
Ouput fall, 0.05
Depreciation say 0.1
Savings rate say 1/3
sA – δ = gc implies
A/3 – 0.1 = 0.05
Hence A =3x0.15 = 0.45= gc
No fall in productivity, b =-0.05=-canonical growth. i.e. 5% off capacity
Period 0
Growt Period 1
Growth
h
1/2
0/1
Q
100
105
Zero
Y
105
C
67
63.3
S=sQ
I=sQ-bK
33
Where K
DK =sQ
–δK-bK
DK/K=
sA-δ-b
100/0.45=222
33 -10/0.45
=33-22=11
.45/3-.1=0.05
Canonical
growth
Assuming b=0.05 and gamma =0.10
Period 0
Growt
h
Q
100
Y
-5%
C
67
S=sQ
I=sQ-bK
33
Where K
DK =sQ
–δK-bK
100/0.45=222
33 -10/0.45
=33-22=11
DK/K=
sA-δ-b
.45/3-.10=0.05
105/3
105/3 – bK=35-11.7
=23.3, so b=0.05
233
105/3-(0.1+0.05)233
=35 – 23.3 - 11.7 =0
0.15-0.10-0.05 = 0
Period 1
105
95approx
63.3
Peri
od 2
105
63.3
35
Zero
233
Growt Period 2
h
check 103.5
+8.9%
65.7
95/3=31.7
95/3 – bK=31.7 -11.7
= 20, where b=0.05
-1%
233
95/3-(0.10+0.05)233
=31.7 – 23.3-11.7 =
-3.3
0.90x0.45/3-0.100.05 = 0.135-0.150 =0.015 more or less
37.8
230
KEYNESIAN CASE
16
Average growth, g = 0.05
Ouput fall, 0.05
Gap = 0.1
Depreciation say 0.1
Savings rate say 1/3
sA – δ = g implies
A/3 – 0.1 = 0.05
Hence A =3x0.15 = 0.45
No demand fall is as above
With demand fall of say (4/3bK) = 29.3! using bK of 22 as above
So assume demand falls by double 20=7.5x 4/3, and use bK of 15, i.e. b= 0.068
?really???
Or assume demand falls by 10=7.5x 4/3, use bK of 7.5, i.e. b= 0.034 only 3.5 % off
Check this: why the big fall in capacity? Higher bK and higher sQ?
Period 1
growth
Expected
Growt
h
Q
100
105
105
Y
95
95
8.9%
C
67
63.3????
63.3????
S=sQ
I=sQ-bK
33
Where K 100/0.45=222
DK =sQ – 33 -10/0.45
δK-bK
=33-22=11
DK/K=
sA-δ-b
105/3
105/3 – bK
=35 -7.5=
27.5, so
b=0.034
233
105/3(0.1+0.034)23
.3 =35 – 23.37.5= 4.2
105/3
105/3 –
bK=35 -15=
20, so
b=0.068
233
105/3(0.1+0.068)23
3 =35 – 23.315=-3.3
Output
103.5
107
12.2
73
36
-1.0%
230
237
.45/3-.10=0.05
0.15-0.100.15-0.100.034 .=
0.068 .=
=0.016 more
-0.018 more
or less
or less
Assume for simplicity that consumption depends both on capacity output and on
current income, specifically
C= (1-s)Q - s(Q-Y) = Q -sY
So Y = C +I = Q-sY + sQ-bK =(1-s)Q –sY -bk
So (1-s)Y = (1-s)Q-bk
So Y=Q-bk/(1-s)
Should give gradual adjustment.
Greater demand fall and smaller cut to capacity:
Even more true if we use full multiplier of.
So assume demand falls by 10=3.3x 3, i.e use bK of 3.3 not 22 as before so b= 0.015
Period 1
growth Expected
Growt Output
h
Q
100
105
108.5
Y
-5%
95
13.7%
17
C
67
63.3
73
S=sQ
I=sQ-bK
33
36
Where K 100/0.45=222
DK =sQ – 33 -10/0.45
δK-bK
=33-22=11
105/3
105/3 – bK=35 -3.3=
31.7, so b=0.015
-1.0%
233
105/3-(0.1+0.015)233
=35 – 23.3 -3.3= 8.4
DK/K=
sA-δ-b
0.15-0.10-0.015.=
-0.035 more or less
.45/3-.10=0.05
241
Note that choosing bK to fit the gap with a powerful short run multiplier involves a
much smaller impacyt on capacity growth. Could increase this by reducing the
multiplier. E.g. reduce this by
18
Download

Marcus Miller and Lei Zhang Abstract