Chapter 12 - Pages 158 - 160

After a good twenty-five years of sustained growth (from WW II to 1969) certain things in economics are going to happen. As assumptions abounded about the end of the business cycle, a new Nobel Prize was created for economics. This also came about as recognition of the third century mark of the world’s first central bank. It was thought that because economists mastered the workings of this fundamental central bank, this led to faster and more dependable growth.

Though there were differences in the economic field, economists were admired and things were at an all time high. Of course, as they say, all good things must come to end. Public opinion dramatically declined and there began to be “furious arguments” within the economic community. By the mid 1970’s “theorists were embroiled in something of a civil war.”

The differences quickly turned to theoretical orientation and what was to be modeled and how. The author tells us what was mostly missed was that these arguments were about new mathematical tools addressing familiar economic problems and none of the new tools were more valuable as the theory of general equilibrium.

Pages 157-158

Closing the last section, all of the young economists that published Essays on the Theory of Optimal Economic Growth abandoned the idea and redirected their efforts in other fields; all except Shell.

Solow gave a benediction on growth theory in 1969 by comparing the theories to reconnaissance exercises. They’re meant to see what it’s like out there before you build a huge model and gather a mountain of data. But theory had no more to offer and the Italian economic journalist Arrigo Levi said, “There are no new discoveries. All the great discoveries have been made.”

For a quarter century after WWII, the U.S., Japan, and Europe all enjoyed sustained business expansion. The business cycle seemed to be tamed or even eliminated after 150 years of wide peak-and-trough behavior. Swedish authorities decided to add economics to the list of Nobel Prizes in hopes that it might bring forth more economic insight and grow the field.

The Residual and Its Critics p.153-157

There were a few interesting topics mentioned in this section. The first would be the movement of new economists to MIT and the arrival of Karl Shell who desired to include technology into the growth problem instead of avoiding the issue. The next point of note would be the "maximum principle" which originated in Moscow and was a way to connect calculus/algebra to topology. Next there was a move from MIT and the economic thought there to Chicago. If I'm not mistaken, Chicago is still the Mecca of economic thought. From Chicago a few of the new growth economists attended a conference in Stanford which brought up an interesting question: "could economic growth be speeded up through policy?" Also mentioned were "turnpikes" which were avenues through which economics could move to higher levels of development by forced investment. However in the summer of 1965 all these new thoughts were squashed and ended up being published with little fanfare as "Essays on the Theory of Optimal Economic Growth" edited by Shell in 1967.

Chapter 11, Pages 148-153

In the field of economics, where consensus can be elusive, plenty questioned whether the "riddle of growth" had really been solved by Solow's model. Keynesians in Cambridge, Schumpeterians at Harvard, and a pair at U.C. Berkeley all made attempts to go beyond the model, but it was the RAND corporation and frequent visitor Kenneth Arrow that went the furthest. Arrow provided two significant insights into the production of knowledge. First, knowledge isn't appropriable. Second, Arrow suggested that knowledge is indivisible, it is a good that is "either altogether present or it (is) not"

Arrow built his model based on knowledge accumulated through experience. By using the idea of rational expectations, he assumed that everyone already knew all there was to know, as soon as others came to know it. These external increasing returns prevented a firm from building a monopoly from its own learning. Due to certain inconsistencies in the model it never became widely used, but several of Arrow’s ideas grew to be very significant.

Pg 147-148

Finally, we are understanding how growth overcomes diminishing returns, by technology growth. All the other important figures in economics understood that technology was important but it is said that Solow put their thoughts into modern calculus. This model became the blueprints for the Cold War, out grow the Soviet Union with technical advances. Growth had now been fit into the Keynesian model and Solow became disinterested and turned his attention elsewhere, helping the government with Cold War issues. Soon he began working on what would become know as the Phillips Curve, which is the theory that inflation and unemployment are linked. "Fine-tuning" the economy soon became a primary focus of polices which lead to the Kennedy tax cuts in 1964.

Pg 145-147

He talks more about Solow model. Explained is how the model changed thinking, by saying the equilibrium was general. It gave the model more flexibility. The system could now adjust and eventually approach a steady state of proportional expansion. Solow's model shows that savings rates don't effect growth rates. Only population and technological growth could effect growth. We get the definition of the Residual "the portion of growth that the model did not explain"

"The 'Solow growth model' is not intended to explain or derive the empirical residual, but rather to demonstrate how it will affect the economy in the long run when imposed on an aggregate model of the macro economy exogenous. This model was really a tool for demonstrating the impact of “technology” growth as against “industrial” growth rather than an attempt to understand where either type of growth was coming from. The Solow residual is primarily an observation to explain, rather than the outcome of a theoretical analysis. It is a question rather than an answer, and the following equations should not obscure that fact."-Wikipedia.com

The Residual and Its Critics p. 141-145

This section of the book introduces the first non-hasty model of Keynesian economics. This model was created by Robert Solow. An interesting point in the background of Mr. Solow was the push into mathematics. I'm not sure if after WWII was the first real push of mathematics into economic models or not, but the author mentions the importance of mathematics in Solow's model. A key improvement to Mr. Solow's model that hadn't been seen before was the shift from fixed capital/output to a variable function that allowed substitution. The model he came up with is Y=A(t)F(K,L) which means that output is a function of labor and capital multiplied by the rate of growth of knowledge. It was assumed that knowledge was to "grow steadily, naturally, with the passage of time." p.145