Page 27 - FINAL CFA II SLIDES JUNE 2019 DAY 4

LOS 12.i: Compare classical growth theory, neoclassical
growth theory, and endogenous growth theory – 3 Models! READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE

EXAMPLE: Estimating steady state growth rate: An MODULE 12.3: GROWTH AND CONVERGENCE THEORIES
analyst is forecasting steady state growth rates for
Country X and Country Y and has collected the
following estimates:
Answer: Sustainable growth rates:

Country X = (2.0% / 0.60) + 1.2% = 4.53%
Country Y = (1.0% / 0.52) + 2.6% = 4.52%

Sustainable growth rates for the two countries are comparable.
• Country X’s sustainable growth rate is primarily driven by higher
growth rate in TFP.
Calculate and comment on sustainable growth • Country Y’s sustainable growth rate is mostly driven by a higher
rates for the two countries. population growth rate.

Under Neoclassical theory:

Capital deepening affects the level of output but not the growth rate in the long run. Capital deepening may temporarily increase the growth
rate, but the growth rate will revert back to the sustainable level if there is no technological progress.

An economy’s growth rate will move towards its steady state regardless of the initial capital to labor ratio or level of technology.

In the steady state:
• (1) the growth rate in productivity = function only of the growth rate of technology (θ) and labor’s share of total output (1 − α); (2) marginal
product of capital (MPK) = αY/K is constant, but marginal productivity is diminishing.

An increase in savings will only temporarily raise economic growth. However, countries with higher savings rates will enjoy higher capital to
labor ratio and higher productivity.

Developing countries (with a lower level of capital per worker) will be impacted less by diminishing marginal productivity of capital, and
hence have higher growth rates as compared to developed countries; there will be eventual convergence of per capita incomes.