Convergence in an open‐economy growth model

Abstract

What does recent work on neoclassical growth models have to say about the time taken to reap the benefits of economic reform? Recent empirical research has seen the emergence of the stylised fact that economies converge to their steady‐state growth path at a rate of 2 per cent per annum ‐ a result which is often taken to imply that the payoff period is quite long. Consistency with this stylised fact has been one criterion for inclusion of human capital and for imposing credit constraints on international borrowing in theoretical growth models. By contrast, data‐consistent models of the kind routinely used for forecasting and policy analysis do not include human capital, often assume perfect capital mobility, and converge at a much faster rate than 2 per cent per annum. This paper reviews the origins of the 2 per cent rule, arguing that existing evidence for the rule is weak and that in any case it can be a misleading guide to the payoff period in policy applications. We then analyse the convergence properties of the NZM model of the New Zealand Treasury, which has an open‐economy Solow‐Swan model as its steady state.