Name	Question
Anonymous Student 1	How will the fear of exposure to the Severe Acute Respiratory Syndrome (SARS) affect trade with other countries and the U.S. economy?
Jay Dixon	With the US taking control of the oil wells in Iraq and using them for a reconstruction batering tool, how does this affect the global economies of the oil industry and industrial countries?
Anonymous Student 2	One of my other professors said that he believed that the advent of the Euro would hasten the making of one country out of many and that the French would be the likely leaders of it. Does this make sense to you and does it have any macroeconomic implications?
Jake Miller	What is the weighted-average interest rate of the United States' government debt? If the return on incomes not taxed is greater than the debt burden, wouldn't it pay off to have an ever-increasing national debt?
Jason Heath	We assume that the stock market follows a random process. To what extent do you believe this to be accurate, and what methods using Markov Chains or other algorithms can best be used to model the market assuming the randomness of the market?
Eren Hernandez	In the past few months, our country has seen a slowdown of its economy. During this time of war, there is a lot of uncertainty about the future that affects both business and consumers in our society. The stock prices suffer a negative effect from the declining worth of the dollar our country has experienced in the past year, 2002. If the war with Iraq continues, will the value of the dollar maintain the same declining trend? If so, what will be the immediate effects that our society will face?
Ryan Pyatt	Did the September 11, 2002 terrorist attacks have a profound long term economic effect on the economy effect on the economy, or was it just a short blip in an already struggling economy that is still trying to recover?
Anonymous Student 4	Is there an exploitable trade-off between inflation and unemployment?
Anonymous Student 5	How are interest rates related to the price level and the inflation rate?
Dusty Roche	Will inflation make us poor by destroying or savings or rich by eliminating our debts? With that in mind, do you believe growth, GDP, unemployment, etc. will stay constant over our changing economy and sectors?
Brad Parker	Why is it bad for the government to run deficits? I know that in theory it really isn't, but there had to be SOME reasons that are negative or why would we even tax at all?
Chris Hansen	What affect will the war have on the exchange rates between the countries in the Middle East?
Anonymous Student 3	With the overthrow of Saddam's regime in Iraq, do you see Iraq's steady state increasing or decreasing?
Jeremy Sumerix	Are stock market crashes a possible indicator of a country experiencing growth faster than it can sustain? (i.e. the Asian stock market crash of 1997)
Andrew Heaton	In dealing with growth theory…in your opinion what events or reasons would cause a steady state to migrate outward? And if one could determine these and cause them, could they manipulate growth rate to help us continue to get richer?
Thomas Cox	In the past, war has been beneficial to economies due to the post war rebuilding. What will the U.S.'s economy be faced with if the UN does the rebuilding of Iraq? Especially since we flipped the bill to liberate Iraq and politically it would be wise to withdraw so as to not appear as an occupying force.
Dan Jessen	Under the Romer Model, can the economies of 'bad' or flawed ideas explain recessions? For example, flaws in our banking system/S.E.C. leading to the Great Depression; or bad dot com/e-commerce business ideas and speculation leading to the dot com bust and so on…
Lucia Olivera	We've heard you say how growth in Latin American countries is slower than what the numbers predict. I am wondering if its possible that the fact that there haven't been any big wars in most Latin American countries since their independence could be a factor affecting its growth. It seems to me that having a war experience makes people think differently, act differently, maybe act more unified, or cohesibely, than those that haven't. But maybe I'm just thinking of the big countries, like USA, Japan, and Germany, which after being almost destroyed by great wars were able to build themselves again with a much stronger foundation. Of course, thre are some developed countries that have done very well without having had any wars for a very long time, such as Switzerland and Canada, and I'm sure there are others.
Lucia Olivera	Are there any studies done comparing growth rates in countries according to how many war periods they've experienced, or if countries that have experienced the horrors of war seem to grow faster or more efficiently than those that have not? What about studies on hw much a war affects the growth variables? If so, what were the results of such research?
Lucia Olivera	Why is the International Monetary Fund (IMF) requiring Argentina (and other countries too, I believe) to cut government spending as a requirement before giving them more loans, when a contractionary fiscal policy does not seem to contribute to long-term economic growth? (I can think of two possibilities: (1) when they say "cut government spending" they mean "stop stealing money from your own government", but, of course, they can't say it, and (2) they don't know much about economics.)
Anonymous Student 4	Why is economic growth slowing in Taiwan but not in China?
Ryan Hawley	Does government deficit directly affect a nation's GDP? If so does it affect it positively or negatively?
Jed Smith	What would be an appropriate way to use the Romer and Solow growth models on a microeconomic level?

How will the fear of exposure to the Severe Acute Respiratory Syndrome (SARS) affect trade with other countries and the U.S. economy?

Gosh ... I wish I had an answer for this one too. Let's think about this in terms of polar cases. The worst case scenario is that this is a contagious disease, for which we have no immunity, which has a 4% death rate. So, we're talking 250 million deaths worldwide. In the best case, a vaccine can be developed quickly with few side effects, and the whole scary situation fizzles out.

I think that its pretty obvious that people are worried about that worst case scenario. Expectations of that scenario could have enormous effects on the world economy without it ever even taking place. Already we are seeing drops in travel to East Asia, recommendations that people avoid travel to Toronto, Beijing, and Hong Kong, empty hotels, closed universities, hospitals and schools, and so on. How much damage is that doing - I don't know, I've heard no estimates. Here's a ballpark figure: big natural disasters in developed countries do $20-100B in damage. The U.S. can shake that off, but Hong Kong, and other small but wealthy countries would be devastated. This probably bears a lot more attention than the Iraq war. On the other hand, don't blow it out of proportion. Only a few thousand people have had SARS so far.



With the US taking control of the oil wells in Iraq and using them for a reconstruction batering tool, how does this affect the global economies of the oil industry and industrial countries?

Probably not too much. First, the price of oil tends to be driven more by uncertainty about supply than by supply itself. So, much of the price spike in oil this year reflects uncertainty about events in Iraq, Venezuela, and Nigeria. A reduction in that uncertainty about the future - which arguably has taken place over the last few weeks - will tend to lower oil prices. That is of course good for just about every countries economy (except those that rely on oil exports). Another thing to keep in mind is that Iraq was forbidden from exporting all the oil it could produce because of U.N. sanctions. Even though they violated that embargo, presumably they will now produce even more now that it will be legal, which will also tend to reduce the price of oil.



One of my other professors said that he believed that the advent of the Euro would hasten the making of one country out of many and that the French would be the likely leaders of it. Does this make sense to you and does it have any macroeconomic implications?

First, I think the creation of the Euro is intended to be an event which fosters unity in Europe. However, I think that unity ultimately has a lot more to do with people's perceptions of whether that is an important and a good thing. I'm not sure that Europeans are convinced of that yet, and if they aren't, then the creation of the Euro is just a cosmetic change.

Do the French think they will be leading a united Europe - quite possibly. Will they be leading a united Europe in our lifetime - probably not. There's a lot of personal opinions I could put in here, but let me try to be stricly factual. Germany is larger than France and always will be - its lead is too big to be overtaken. France is larger than Italy and might not be able to maintain that lead - France's lead is much more narrow, and Italy is more economically dynamic than France. Also, to the credit of France, their country has been largely free of idiosyncratic economic problems over the last fifty years. Germany has had to absorb and digest the old East Germany. Italy has had to deal with a poor and backward southern region. Once they deal with either of those, their growth catch-up will swamp France. It isn't clear if the United Kingdom will ever be part of a united Europe, but it is in a similar position to Italy.

I think politically that France is trying to position itself as the part of a united Europe with political power that exceeds its economic power or population. That is possible - the southern states have done that in the U.S.

At a basic level, I don't think the transition from a bunch of European currencies to a bunch of countries sharing the Euro will have many macroeconomic implications.

On a more complex level, one of the poorly understood ideas about exchange rate systems is that flexible exchange rates greatly diminish the ability of wealth to move across borders. The reason is that flexible exchange rates change fast enough to eliminate any incentive to move wealth across borders. What has happened in Europe is that those countries have gone from a system where they had flexible exchange rates with everyone (both inside and outside Europe), to a system in which they now have fixed exchange rates within Europe. This will allow wealth to flow a lot more freely in Europe, and probably in the direction of countries which position themselves to best grow in the near future (I'm not going to speculate on which countries fit that description).

How does this odd idea work? If you sell something in a foreign country, you get paid in the currency of that country. You now have two choices. Buy something there with that currency and ship it home, or convert that foreign currency back to your currency. Most people choose the latter (probably because cash is easier to work with). Here's where exchange rates come in. Under flexible exchange rates you exchange equal amounts of the the one currency for another. In order for this to take place there must be someone from the foreign country in your country who is in the same predicament, with the same amount of money to exchange. When both of you are satisfied by getting your own currency back, there is very little chance for net change in wealth across borders. Alternatively, under fixed exchange rates, the goverment agrees to pay you in any form of wealth you wish at the fixed rate. So, if you want, you can ask for gold and carry it back home. If this sort of transaction goes too heavily in one direction it can drain the wealth out of a country. The reason that this can lead to a net change in wealth across countries is that a government often has very little interest in negotiating an exchange rate with an individual to prevent that (in fact, they may even offer a fixed exchange rate for political rather than economic reasons). So, where two individuals would negotiate an exchange of currencies that left each of them in approximately the same position, an individual may be presented with a fixed exchange rate by a government which isn't interested in policing whether that individual transaction leads to a wealth shift. So, if they're not paying attention, it may happen. Nonetheless, they may allow this to happen if they are maintaining a fixed exchange rate for other reasons (I'm being cynical here, but a lot of that may be nothing more than people in government wanting to have their whims obeyed - and the fixed exchange rate is just another whim).

Has this ever happened before? Absolutely - but people just don't recognize it. The U.S. trades with Japan through a flexible exchange rate system, and while that trade makes both countries richer, and can hurt individual workers, it doesn't make either country richer at the expense of the other. Alternatively, the U.S. (or any other country) is a good example of a place with fixed exchange rates. And yes, wealth can be transferred from one region to another. When you drive to St. George to shop, any wealth you spend can and does stay there (although you do trade for some of that, so it isn't like every dollar is lost) because Cedar City has fixed exchange rates with St. George.



What is the weighted-average interest rate of the United States' government debt? If the return on incomes not taxed is greater than the debt burden, wouldn't it pay off to have an ever-increasing national debt?

I don't think the first part of this question is answerable. First, I don't think the Treasury publishes information that detailed about their issues. Second, how would you count the interest rate today of a bond sold some time in the past at a discount?

The second part of the question has got a whole bunch of problematic issues with the question, but the underlying idea is perceptive. First, I'm not sure what is meant by "incomes not taxed". The only sort of bond income that isn't taxed is municipal bond income. Second, the "debt burden" is not something which has an accepted definition. Third, "wouldn't it pay off to have an ever-increasing national debt" is a lot closer to being true than most people would ever guess. The vast majority of national debt in a developed economy with thick financial markets is tantamount to borrowing from your left pocket to loan to your right. On net, it has no impact on the economy. But, those sort of transfers are virtually costless, and actually do grow with population and income. So as both of those go towards infinity, it is plausible that it would be good if debt did too!

After talking this over in class, Jake clarified that what he was really driving at was an idea that macroeconomists call optimal taxation. It's about how a government should choose whether to tax or borrow. Any economic decision is optimized when its marginal benefits equal its marginal costs. The marginal benefits of either taxation or borrowing are the government spending that they fund, which is the same whether the money is raised the one way or the other. So, the problem amounts to setting the marginal costs of taxation equal to the marginal costs of borrowing equal to the marginal benefits of government spending. The latter part of that is difficult to measure empirically (e.g., how do you value national defense spending), so there isn't a lot said about whether the amount of government spending is optimal or not. The empirical evidence on marginal costs of taxation and borrowing are not sharp enough to give us a really good answer, but they do indicate that the amount of borrowing should be greater than zero. If that is the case, then the national debt should grow towards infinity as the economy grows.



We assume that the stock market follows a random process. To what extent do you believe this to be accurate, and what methods using Markov Chains or other algorithms can best be used to model the market assuming the randomness of the market?

The test of whether a stock index, or any other variable is a random process is whether any method can predict it better than chance.

Having said that, there are five points to make.

First, the trend in stock indices is predictable. Several students in class were able to make fairly nice out-of-sample forecasts of stock indices by extrapolating past average growth rates.

Second, growth rates or changes in stock indices are essentially impossible to forecast.

Third, a process with unpredictable changes but predictable trends is called a random walk with drift. It essentially says that the growth rate is centered on some number other than zero (which can be extrapolated), but that fluctuations around that number are random.

Fourth, it is possible that stock indices only appear to be a random walk with drift, but in fact are something much more predictable. It is possible that in the future someone might be able to figure out how to forecast it. But ... the theory that stock prices are a random walk with drift has been around for almost forty years, and no one has been able to disprove it. Further, there is more money and brain power working on this problem than probably any other at any time in human history - with no luck. On a personal level, I once thought that this idea sounded silly, and that of course someone (maybe me!) would figure out how to forecast stock indices. I became convinced that that was futile a long long time ago.

Lastly, there are some very minor predictable components to stock indices. Exploiting them requires a huge pool of investment funds: the gains are so small that they are swamped by transactions costs unless you start with a lot of money.



In the past few months, our country has seen a slowdown of its economy. During this time of war, there is a lot of uncertainty about the future that affects both business and consumers in our society. The stock prices suffer a negative effect from the declining worth of the dollar our country has experienced in the past year, 2002. If the war with Iraq continues, will the value of the dollar maintain the same declining trend? If so, what will be the immediate effects that our society will face?

The value of the dollar is a funny thing. It can actually be shown (it's not easy, so don't ask) under flexible exchange that the exchange rate isn't tied to any particular value. It has no 'central location' to which it tends to return to.

Appreciation and depreciation are caused by people wanting dollars or wanting to get rid of them. If the value of the dollar were to continue to depreciate, it would mean that people were consistently showing a preference for trading in their dollars for other currencies. Could that happen as a result of the situation in Iraq? Absolutely it could. But ... the dollar could also appreciate if people thought that in spite of our troubles, this was still a better place to trade than other countries.



Did the September 11, 2002 terrorist attacks have a profound long term economic effect on the economy effect on the economy, or was it just a short blip in an already struggling economy that is still trying to recover?

It was a blip. The magnitude of the damage from the attack (under $100 billion) is small compared to the size of the economy ($10,000 billion).

Also, the impact of events like this (or natural disasters) is poorly measured in GDP. A structure - like the World Trade Center - is counted in GDP when it is built. After that, it is part of wealth rather than GDP. When the World Trade Center was destroyed, that loss of wealth does not enter into GDP. However, the cost of cleanup, repairs and rebuilding does count in GDP.



Is there an exploitable trade-off between inflation and unemployment?

A majority of macroeconomists no longer think so. The supposed trade-off is summarized by the Phillips Curve. The Phillips curve was incorporated in Keynesian models in the early 1960's as a way to bridge Keynes's good explanation of the price level with his lack of explanation of inflation. In some sense, it was a piece people thought fit well.

Initially, macroeconomists thought that the Phillips Curve implied a trade-off between inflation and unemployment. The majority have changed their minds. Why?

It turns out that the Phillips Curve is a pattern in the data that shows up under the right circumstances. The proper circumstances amount to not trying to control or target inflation or unemployment. In some sense, when left alone, the economy displays a Phillips Curve. The problem is that as soon as you try to do something intentional about inflation or unemployment it goofs up that Phillips Curve relationship.

So, this is weird, but the bottom line is the trade-off only seems possible when you're not trying to make a trade-off. As soon as you start trying to make a trade-off, the appearance that that is possible goes away.



How are interest rates related to the price level and the inflation rate?

Interest rates are only barely related to either the price level or the inflation rate. They are tightly related to a similar idea: the expected rate of inflation.

When a lender is calculating what interest rate they need to charge, they are envisioning a mark-up over the inflation rate that will occur over the life of the loan. Since that inflation will occur in the future - and isn't known yet - it is an expectation of the rate of inflation that most closely determines the interest rate.



Will inflation make us poor by destroying or savings or rich by eliminating our debts? With that in mind, do you believe growth, GDP, unemployment, etc. will stay constant over our changing economy and sectors?

That first sentence is precisely the way that an economist starts to think about a problem. The key is to carry that line of thinking one step further. Both of those outcomes 1) seem plausible, 2) are opposites of each other, and 3) don't tend to happen in the real world. The only way to reconcile those three ideas is to realize that we are in balance between those two extremes: that's why economists are so hung up on equilibrium.

How can this be so? Well, people with savings know the only way they can keep their savings from being eroded by inflation is to loan them out at a higher interest rate. Alternatively, people who want to borrow attempt to keep that interest rate as low as possible. Because no one is forcing the two groups to get together involuntarily, they will settle on a rate that satisfies both groups of people. This will be one that is high enough so that savings are not eroded by inflation, and low enough that people are not unduly burdened every time they borrow money.

As to the second part of the question, I hope you've learned from this class that all of these things fluctuate to some extent. Growth rates fluctuate around a value that is low and stable because we are near a steady state. Unemployment (rates) fluctuate around the natural level of unemployment - corresponding to people voluntarily separating from their jobs. Lastly, GDP trends upward because it is an accumulation of growth.



Why is it bad for the government to run deficits? I know that in theory it really isn't, but there had to be SOME reasons that are negative or why would we even tax at all?

This is a really useful question, but the bottom line is that a majority of macroeconomists no longer think that there is a big distinction. It really seems to just be habit to think of taxation as a good way to finance a government, and borrowing as a bad way.

Having said that, there are two important considerations. First, taxation is involuntary, while lending to the government is voluntary. That would tend to make the latter more preferable. Second, taxation can be targeted at whomever you wish, whereas borrowing on the open market leaves open the possibility that foreigners will be the only ones who want to lend to you - which could ultimately put a country in a compromising position. That argument would seem to make taxation more beneficial.



What affect will the war have on the exchange rates between the countries in the Middle East?

That's almost impossible to answer. When flexible, exchange rates do not have a tendency to go to any value, so there is no answer. When fixed, exchange rates wouldn't change - so the war would do nothing. However, most rates are only fixed for a period of time, before a government decides to change them. We probably can't predict that, so again there is no good answer.



With the overthrow of Saddam's regime in Iraq, do you see Iraq's steady state increasing or decreasing?

I'm speculating, but I would say their steady state per capita income would have to improve. I'm guessing that their policy actions over the last 20 years have not been favorable towards growth - but there is no way to tell that without data, and they didn't keep reasonable economic records.



Are stock market crashes a possible indicator of a country experiencing growth faster than it can sustain? (i.e. the Asian stock market crash of 1997)

It isn't clear that stock market crashes are an indicator of much at all. Stock market indices are a leading indicator for real economic activity, but none of the leading indicators is very good. Remember Samuelson's quote "the stock market has predicted 9 of the last 5 recessions".

Having said that, many economists feel that stock market indices are as good an indicator as any of what current sentiments are about future economic potential. Could investors in Asian stock markets have been worried about Asian growth being unsustainable? Quite possibly, but I don't think their perceptions of the future were that sharp. But ... here's something more concrete that might have been easier to forecast. What if they saw - not that high growth rates were not sustainable - but rather that government policies that were encouraging high growth rates were not sustainable. For example, most of those countries were trying to maintain a fixed exchange rate while running expansionary monetary policies. There were a lot of people at that time who recognized that as a potential problem; and if they acted on that and sold out of those stock markets it would have forced prices down.



In dealing with growth theory…in your opinion what events or reasons would cause a steady state to migrate outward? And if one could determine these and cause them, could they manipulate growth rate to help us continue to get richer?

I don't know of any events that could cause a steady state to move out (perhaps something like aliens arriving and giving us new technology). Reasons that steady states might move out are easy to come by: 1) increasing savings/investment rates, reducing depreciation rates, and 3) adopting a more favorable business climate. Also, reducing population growth rates and technological growth rates move steady states out - but recall that we want the levels of population and technology to be high (and the only way to get that is to have them grow). Also, I gave a list of controllable things in class that promote growth (increasing life expectance, rule of law, increased secondary schooling, thicker financial markets, and increasing educational spending) and that deter growth (fertility, government waste, underground economies, and political instability).

As to whether these could be manipulated, some would be easier and some would be harder. But, the theory and the evidence indicates that if you can do that you can move the steady state.

Even so, the most important factor in moving that steady state outward is still the accumulation of new ideas. That's probably where we should focus our efforts.



We've heard you say how growth in Latin American countries is slower than what the numbers predict. I am wondering if its possible that the fact that there haven't been any big wars in most Latin American countries since their independence could be a factor affecting its growth. It seems to me that having a war experience makes people think differently, act differently, maybe act more unified, or cohesibely, than those that haven't. But maybe I'm just thinking of the big countries, like USA, Japan, and Germany, which after being almost destroyed by great wars were able to build themselves again with a much stronger foundation. Of course, thre are some developed countries that have done very well without having had any wars for a very long time, such as Switzerland and Canada, and I'm sure there are others.

I think that is a fascinating idea. Unfortunately, I'm not sure I'd want to be seen as recommending war as a tool of economic policy.

I don't actually know any of the evidence to support this, but my understanding is that sociologists and political scientists have actually studied the idea that war focuses a country's citizens on its national interests. Certainly, this is an explicit part of the political thinking of some fascist parties (like the Nazi's and the Baathist's).

I also know that many Latin American intellectuals claim that the whole region is a little 'sleepy' and could use a good wake-up call.

On the other hand, there have been some wars in Latin America. Mexico fought an explicit war with the U.S., and has been invaded by us a couple of other times. Peru, Bolivia and Chile fought two wars in the 19th century. Shouldn't these have 'woken them up'? Further, it's hard to argue that Argentina was 'woken up' by the complete failure of their war with the United Kingdom in 1982.



Are there any studies done comparing growth rates in countries according to how many war periods they've experienced, or if countries that have experienced the horrors of war seem to grow faster or more efficiently than those that have not? What about studies on how much a war affects the growth variables? If so, what were the results of such research?

This is a lot harder to research than it sounds. First off, the intensity of the war would make a difference - and how would you capture that effect? Then, there is a pattern in international relations that democratically elected governments don't attack other democratically elected governments. There is another pattern of social behavior that accurate measurement of economic variables is a function of openness of a society. If you put these together, you end up with the peaceful countries having good data, and the warlike countries having bad data - so it's almost impossible to be concrete.

The definitive source on this stuff (Economic Growth by Robert J. Barro and Xavier Sala i Martin, McGraw-Hill, 1995) studied the period from 1960-85 when 39% of countries were involved in some sort of external conflict. What they found was that the effect was negative but insignificant. Alternatively, coups, which are often internal military conflicts were found to have a negative and significant effect on growth rates.



In the past, war has been beneficial to economies due to the post war rebuilding. What will the U.S.'s economy be faced with if the UN does the rebuilding of Iraq? Especially since we flipped the bill to liberate Iraq and politically it would be wise to withdraw so as to not appear as an occupying force.

I wouldn't say that war is economically beneficial. What I would say is that postwar periods often have higher growth rates - because the war damage has pushed countries further away from their steady states.

Since the U.S. suffered no significant damage from the war with Iraq, it's hard to see how this effect could work here this time around.

Iraq suffered some damage in this war, but nothing remotely like Europe or Japan did in World War II. So, you'd expect their growth rates to rise, but not by much.

This is opinion, but I can't see the U.N. doing a very good job of any rebuilding effort in Iraq. Their track record is not good.



Under the Romer Model, can the economies of 'bad' or flawed ideas explain recessions? For example, flaws in our banking system/S.E.C. leading to the Great Depression; or bad dot com/e-commerce business ideas and speculation leading to the dot com bust and so on…

I've never heard of anyone doing this, but I'm sure this would work on paper. Suppose that we invested to come up with new ideas, that on average they were beneficial, but which contained randomly distributed bad ideas. True random behavior can still be lumpy (think about flipping a coin and getting heads several times in a row). So, a random distribution of bad ideas might still have some periods where they were more common, and that could lead to a recession.

I think this would even work in practice. The problem being how would you measure the badness of an idea? If you can't measure it, how would you know whether the theory was correct or not? We don't have that problem with good ideas because - even though we can't measure their goodness - we're pretty sure that most ideas are good, and we know that economies generally grow. Together those seem to confirm the theory.

There actually is a branch of macroeconomics called real business cycle theory. Their argument is that a growth model is an accurate predictor not only of long-run tendencies, but also of short-run business cycle movements. It works like this. In some sense an economy is always 'chasing' a steady state: an economy moves towards the steady state, and if the steady state moves to a new point, the economy changes direction to follow it. The vision of real business cycle theorists is that steady states actually move quite a lot, and that they occassionally move backward (to lower levels of per capita income). They view steady states as moving frequently because the rate of creation of new ideas is not constant. If it slows down, so does the economy.

The difficulty that real business cycle theorists have is that good and bad periods in the economy are autocorrelated. This is the same idea that is in the Markov-switching model that you are most likely to remain in the state you are already in. Real business cycle theorists don't want to assume that the creation of ideas is autocorrelated: this would be like arguing that the Great Depression was an extended period of collective stupidity. So, what they look for is mechanisms that could stretch the occassional randomly occurring period of slow technological progress out into a full blown recession. That's called a propogation mechanism. The candidates that they've looked at so far - primarily intertemporal substitution of labor (you work less when paid less), sticky prices (firms don't change prices as often as they should because it costs real dollars to change marked prices) and labor hoarding (firms don't fire as many people as they should) - don't seem to create enough propagation. So, most macroeconomists are convinced that growth theory is correct, but are less convinced that real business cycle theory is correct.



Why is the International Monetary Fund (IMF) requiring Argentina (and other countries too, I believe) to cut government spending as a requirement before giving them more loans, when a contractionary fiscal policy does not seem to contribute to long-term economic growth? (I can think of two possibilities: (1) when they say "cut government spending" they mean "stop stealing money from your own government", but, of course, they can't say it, and (2) they don't know much about economics.)

This is primarily reason number 1. Experience shows that most governments in developing countries are run by kleptocrats (many governments in developed countries are too). Also, poorly designed democratic systems are easily hijacked by interest groups that funnel spending towards themselves (this is called rent-seeking, and Public Choice is the branch of economics that studies it).

The I.M.F. is full of economists who do know what they're taking about. The problem is that the I.M.F. has evolved into an organization that implicitly views two of its goals to be: 1) offer advice consistent with previously pursued policies in successful countries, and 2) don't suggest any advice that - if it turned out badly - might lead to a particular donor country being blamed. So, their advice inclines towards what is commonly accepted (deficits are bad), and away from what has only been tried in some places (cutting marginal tax rates).

Generally speaking, cutting government spending has been shown to be successful in a wide range of countries over the last twenty years. So, it is now standard I.M.F. advice.

A third reason is that both the I.M.F. and the World Bank were created simultaneously out of the 1944 Bretton Woods meetings that designed post-war institutions. The I.M.F. has been historically dominated by Europeans, while the World Bank has been dominated by Americans. Since Keynesian and Socialist policies are more popular in Europe, they tend to be more heavily pushed by the I.M.F.



Why is economic growth slowing in Taiwan but not in China?

Taiwan is approaching the same steady state per capita income that other developed countries are already at. This will slow their growth rates. China is very far away from their steady state. Their economy is growing quickly now, but their growth rates will slow in the future too. This probably means that the ratio of the size of Taiwan's aggregate economy, compared to China's, probably peaked out 10-15 years ago when China's growth rates began to rise substantially.



Does government deficit directly affect a nation's GDP? If so does it affect it positively or negatively?

I don't think anything affects GDP directly - it's all indirect. Even so, I'm not sure that deficits are that important.

Deficits fluctuate probably more than any other major macroeconomic variable. If they had a serious effect on GDP, you'd notice it.

Another factor to think about is that what is commonly announced in the media is the government's deficit over some annual period. What some people worry about is whether that number is too big or too small. Unfortunately, if you delve a little deeper, what you realize is that the government runs deficits or surpluses depending on the month: deficits most of the year, with big surpluses in April (when most income tax is paid), smaller ones in August and October (when income tax deferrals are due), and also in July, October, and January when people who don't have tax withheld are required to send in checks. So, if deficits were bad (or good), you'd see a pattern in GDP that tracked actual payments of taxes. Nobody has ever spotted such a thing, and if there is no evidence at a monthly level, how likely is it that something will show up when you aggregate those months?

For completeness, the theory on deficits can be broken down into four components. Keynesians believe that deficits are good because they reflect government spending (which is expansionary) not being cancelled out by tax revenues (which are contractionary). People reacted to that in the 1960's by coming up with the idea of crowding out: that government borrowing - even though it is beneficial under Keynesian theory - comes with this other cost that private business may not be able to afford to borrow needed funds because the government has bid up interest rates. The third idea is Ricardian equivalence: that government borrowing doesn't matter because all it does is substitute taxes not leveled today for other taxes in the future (to pay off the borrowing). A fourth idea (which has not been sufficiently thought through to be called a theory) was pushed by Clinton's first Secretary of the Treasury Robert Rubin. His thinking was that avoiding deficits would help convince people that the government was serious about restraining its spending and would therefore help the economy. So, the theories of the effects of deficits run the gamut from benefical to unimportant through harmful.



What would be an appropriate way to use the Romer and Solow growth models on a microeconomic level?

Actually, the Romer and Solow models are microeconomic models! This will take a while to explain, so bear with me.

Up until Keynes, there was no microeconomics and macroeconomics, it was all just economics (we now call pre-Keynesian economics classical economics). Keynes and the Keynesians that followed him developed macroeconomics from a completely different set of axioms than microeconomics (e.g., microeconomics uses optimization subject to constraints, rationality, and the importance of relative prices to frame its arguments, while Keynesian macroeconomics uses accounting identities, the fallacy of composition, and the importance of the absolute level of prices to frame its arguments).

Starting in the early 1950's, many economists started looking for the microfoundations of the then ascendant Keynesian macroeconomics (Friedman in 1976, Tobin in 1981, and Modigliani in 1985 won Nobel prizes in part for this work). This movement is similar philosophically to those in other sciences (like microbiology versus biology, or physics versus chemistry) in which better explanations for the behavior of large systems are sought by a finer understanding of mechanisms operating at smaller and smaller levels (if you put the keywords micro, macro and philosophy of science into an internet search engine, you will come with hits from many scientific fields).

The first theory in which a microeconomic framework is used to address a macroeconomic question is in fact the Solow growth model (published in 1956, Solow won a Nobel prize for this in 1987). This was extended by Peter Diamond ("National Debt in a Neoclassical Growth Model," American Economic Review, 1965, volume 55, pp. 1126-1150) and David Cass ("Optimum Growth in an Aggregative Model of Capital Accumulation," Review of Economic Studies, 1965, volume 32, pp. 233-240) in the mid-1960's, and their models are true microeconomic models. Of course, you can probably imagine that the next thing I'll note is that Diamond and Cass are on everyone's short list for a Nobel Prize in the near future.

By the 1970's, there was a full-fledged revolt against the Keynesian paradigm of using a completely different form of model for macroeconomics than microeconomics. The leader of this movement was Robert Lucas (who won a Nobel Prize for his work in 1995). By the late 1970's, some top level macroeconomists were using completely microeconomic models to address all relevant macroeconomic questions.

This new breed of macroeconomics was called new classical economics, obviously because it was new, and also because it bore a strong resemblence to the plain old (classical) economics practiced before Keynes. The one idea that it retained from Keynes was the idea that macroeconomics should be studied as a general equilibrium problem. Economics has two modelling traditions: partial equilibrium (pushed by Marshall starting in the 1870's) and general equilibrium (pushed by Walras starting in the early 20th century). Marshallian partial equilibrium is what you do in Principles of Microecomics when you talk about supply and demand in isolation from other factors. Walrasian general equilibrium is what you do in the Solow growth model when you have a list of equations with exogenous and endogenous variables and you make sure that you have enough equations to solve for the endogenous variables.

Starting in the 1950's, Arrow and Debreau (who won their Nobel Prizes in 1972 and 1983) worked out the microeconomics of perfect competition in a general equilibrium framework. But, they ran into a roadblock when they started to think about how general equilibrium would work with imperfect competition. That started to get worked through in the 1970's by Spence and Stiglitz (who won their Nobel Prizes in 2001, in part, for this work) and Dixit, Helpman, Krugman and Lancaster (who are still waiting for theirs).

Believe it or not, this all comes back to Romer. He worked as a graduate student under Lucas in the mid-1980's, where he combined Solow's growth model with the recent work on general equilibrium with imperfect competition to write the seminal papers in new growth theory (for which he is guaranteed a Nobel Prize in the near future).

So, the bottom line here, is that a microeconomist would see very little that was unfamiliar in a growth model, and if they wanted to address a growth question in microeconomics they would use this model. In fact, they do use growth models to think about how big an industry will get, and then they use industrial organization to think about how that industry will be subdivided into individual firms.