Working Paper: CEPR ID: DP3435
Authors: Berthold Herrendorf; Akos Valentinyi
Abstract: This Paper explores the local stability properties of the steady state in the two-sector neo-classical growth model with sector?specific externalities. We show analytically that capital adjustment costs of any size preclude local indeterminacy nearby the steady state for every empirically plausible specification of the model parameters. More specifically, we show that when capital adjustment costs of any size are considered, a necessary condition for local indeterminacy is an upward-sloping labour demand curve in the capital-producing sector, which in turn requires an implausibly strong externality. We show numerically that capital adjustment costs of plausible size imply determinacy nearby the steady state for empirically plausible specifications of the other model parameters. These findings contrast sharply with the previous finding that local indeterminacy occurs in the two-sector model for a wide range of plausible parameter values when capital adjustment costs are abstracted from.
Keywords: Capital adjustment costs; Determinacy; Externality; Local indeterminacy; Stability
JEL Codes: E00; E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital adjustment costs (G31) | local indeterminacy (D89) |
| capital adjustment costs (G31) | stability of the model (C62) |
| production possibility frontier (concave) (D24) | local stability (C62) |
| capital adjustment costs of plausible size (G31) | determinacy nearby the steady state (C62) |
| upward-sloping labor demand curve (J29) | local indeterminacy (D89) |