A Contribution to the Empirics of Economic Growth

This 1992 Quarterly Journal of Economics paper by Mankiw, Romer, and Weil tests whether Robert Solow’s (1956) neoclassical growth model, augmented to include accumulation of human as well as physical capital, can account for the enormous cross-country variation in income per capita. Using Summers-Heston national accounts data for three samples of countries (98 non-oil countries, a 75-country intermediate sample excluding low-data-quality and very small countries, and 22 OECD countries) over 1960-1985, the authors first show that the textbook Solow model (with only physical capital) gets the signs of the effects of the investment rate and population growth right and explains a majority of cross-country income variation, but implies an unrealistically high capital share of income – roughly 0.6-0.8 in the estimated regressions rather than the roughly one-third value implied by independent data on factor shares. Adding a proxy for human-capital investment (the fraction of the working-age population enrolled in secondary school) to the regression raises the explained variance to about 80 percent and brings the implied capital and human-capital shares close to their independently known values of about one-third each, without rejecting the restriction that the model’s coefficients should sum to zero. The paper further argues that the well-documented absence of unconditional convergence across countries does not contradict the Solow model, because the model predicts only “conditional convergence” – convergence toward each country’s own steady state, determined by its own saving, population growth, and human-capital investment rates – and the data show a statistically and economically significant conditional convergence at a rate, implying a roughly 35-year half-life to steady state, reasonably close to what the augmented model predicts. Finally, the paper argues that apparently puzzling patterns in international interest-rate differentials and capital flows (the Feldstein-Horioka finding that capital does not flow from high-saving to low-saving countries) do not straightforwardly contradict the model once one allows for imperfect capital markets and expropriation risk, and that direct evidence on profit rates and returns to schooling is, if anything, consistent with the Solow model’s prediction of higher returns to capital in poorer countries. The authors are careful to note that this defense of the Solow model does not make it a complete theory of growth, since it still treats saving rates, population growth, and worldwide technological change as exogenous, and that endogenous-growth models may still be needed to explain those more fundamental determinants.

The Inexorable and Mysterious Tradeoff between Inflation and Unemployment

The consensus view that contractionary monetary shocks raise unemployment but only slowly and gradually lower inflation is, this lecture argues, flatly inconsistent with the forward-looking “new Keynesian Phillips curve.” Delivered as the Harry Johnson Lecture, the paper first argues the inflation-unemployment tradeoff – properly understood as a claim about the effects of monetary policy, not a stable scatterplot relationship – is “inexorable,” tracing the idea to Hume’s 1752 observation that a monetary injection first raises output and employment and only later raises prices, and noting the broad modern consensus (even among former real-business-cycle theorists) that monetary policy is non-neutral. The paper’s central contribution is a diagnostic: given a plausible, widely agreed impulse response of inflation to a monetary shock (no effect for two quarters, then a delayed, gradual disinflation peaking around 9 quarters), any specific Phillips-curve model implies a corresponding impulse response for unemployment, which can be checked against the well-known facts that unemployment rises promptly and its peak effect precedes inflation’s peak effect. Traditional backward-looking Phillips curve models pass this test easily, but the forward-looking new Keynesian Phillips curve fails badly: fed the same delayed-inflation-response assumption, it implies unemployment should fall, not rise, during the contraction – “precisely the opposite of what we know to be true” – because forward-looking firms observing a slow-moving disinflation can only rationalize not cutting prices faster by simultaneously expecting future unemployment to be lower. The paper works through several candidate fixes – Fuhrer-Moore-style backward-looking wage contracts, delayed information among price-setters (Rotemberg-Woodford), and outright adaptive expectations – and finds each either insufficient (a short information lag “doesn’t help the model match reality” beyond that lag) or unsatisfying (adaptive expectations “resolves” the puzzle only by discarding rational expectations, which the paper is reluctant to do given how closely the public tracks monetary policy news). It concludes that while the existence of a short-run inflation-unemployment tradeoff is secure and well grounded in price-stickiness theory, the dynamic relationship between the two variables – how one translates into changes in the other over time – remains a genuine, unresolved puzzle for business cycle theory.

N. Gregory Mankiw | Macro Paper Warehouse

A Contribution to the Empirics of Economic Growth

The Inexorable and Mysterious Tradeoff between Inflation and Unemployment