The Hansen-Prescott (2002) model

Long-run growth model

Two sectors:
Malthus sector using land, labor, capital
Solow sector using labor, capital
Population evolves according to an exogenously given function of consumption
(here actually wages)
Transition
from Malthusian economy, with stagnant living standards and only Malthus
sector active
to Solow economy, growing living standards and both sectors active
Production:
Y
A,t
=
A,t
1

A,t
.
j
A,t,
1
1j
Y
S,t
=
S,t
1
1j
S,t
.
j
S,t

i,t
= total factor productivity in sector i
1
i,t
= capital
.
i,t
= labor
1 = land (exogenous)
i = A, S (Malthus, Solow)
Productivity growth:

A,t+1
=
A

A,t
,

S,t+1
=
S

S,t
,

S

A
:
.,t
= fraction labor in Solow sector
:
1,t
= fraction capital in Solow sector
Clearing factor markets:
:
1,t
= 1 \
t
,
:
.,t
=
(1 \
t
)
+ (1 j ) \
t
,
\
t
= min
8
>
>
<
>
>
:
1,
2
4

1 j
!
1j

A,t

S,t
3
5
1
1j
1
1
t
9
>
>
=
>
>
;
Malthus to Solow transition when low enough TFP ratio, and/or land-capital
ratio
Agents
Two-period OLG
Dierent ways to model ownership of land
No property rights: land controlled and shared in equal parcels by the
young in any given period; left to next generation when turning old (easier
approach)
With property rights: markets for land where old agents sell to young
at endogenously determined price (more dicult, done by Hansen and
Prescott)
Here: no property rights
Budget constraints
c
1,t
= &
t
+v
1,t
|
t
c
t
c
2,t+1
= (1 +v
1,t+1
)c
t
c
t
= saving
&
t
=wage
v
1,t+1
=real interest rate
v
1,t
=rental price of land
|
t
= 1.
t
= land per young agent
Utility
l
t
= (1 o) ln(c
1,t
) +o ln(c
2,t+1
)
Saving:
c
t
= o
h
&
t
+v
1,t
|
t
i
Fertility, a
t
, function of wage, &
t
a
t
= a(&
t
) =
8
>
>
<
>
>
:
b +
(a

b)&
t
&

if &
t
< j&

a1
ij

&
t
&

if &
t
2 [j&

, i&

]
1 if &
t
i&

b =
ja

a
j 1
o =
ia j
i j
Parameters &

, a, a

, i and j dene fertility behavior

&

0, a a

, i j 1
Note:
a
0
(&) 0 for &
t
< j&

&

and a

= wage and fertility rates on a Malthusian balanced growth

path (when Solow sector not active)
Fertility peaks at a, when &
t
= j&

Then declines until the wage rate reaches i&

After that a
t
= 1, population remains constant
Population evolves according to .
t+1
= .
t
a
t
Malthusian balanced growth path
Set Malthusian fertility rate, a

, so that wages are constant (at &

) on balanced
growth path; gives
a

=
1
1j
A
Why? Use
Y
At
=
A,t
1

A,t
.
j
A,t
1
1j
=
A,t
1

t
.
j
t
1
1j

A,t+1
=
A

A,t
.
t+1
= .
t
a

&

= j
A,t
1

t
.
j1
t
1
1j
= j
A,t+1
1

t+1
.
j1
t+1
1
1j
Constant capital-labor ratio implies 1
t
and .
t
grow at same rate, a

Dynamics
4 state variables that determine everything else: 1
t
, .
t
,
S,t
,
A,t
Last two evolve exogenously
Find dynamics of capital and population
Capital
Capital made up of previous periods saving
1
t+1
= c
t
.
t
= o
h
&
t
+v
1,t
|
t
i
.
t
= o
h
&
t
.
t
+v
1,t
1
i
where &
t
and v
1,t
are given by the marginal products to labor and land:
&
t
=
jY
A,t

1 :
.,t

.
t
v
1,t
=
(1 j )Y
A,t
1
1
t+1
= o

1 j +
j
1 :
.,t
!
Y
A,t
Note spurt in capital accumulation when :
.,t
increases
Population
Recall exogenous fertility function, a(&
t
)
.
t+1
= .
t
a(&
t
)
where &
t
is given above
Transition
The Solow sector becomes active when \
t
falls below 1, which occurs when

S,t

1 j
!
1j
2
4

A,t

1
1
t
!
1j
3
5
.
Paths very easy (in principle) to simulate
Start with 1
0
, .
0
,
S,0
= 1,
A,0
= 1 (pick 1
0
, .
0
so that Solow
sector is not active and economy is on Malthusian BGP)
Compute :
.,t
, :
1,t
, &
t
, v
1,t
, Y
A,t
for t = 0
Use dynamic equations to update 1
t
, .
t
,
S,t
,
A,t
to t = 1
Repeat
See gures for example
-4 -2 0 2 4 6
1
1.1
1.2
1.3
1.4
1.5
Panel A: fertility


Fertility
-4 -2 0 2 4 6
10
-2
10
-1
10
0
10
1
Penal B: population and capital stock


Population
Capital stock
-4 -2 0 2 4 6
10
0
10
1
10
2
Panel C: wages


Wage rate (w)

-4 -2 0 2 4 6
0
0.2
0.4
0.6
0.8
1
Panel D: shares of capital and labor in Solow sector


z
K
z
N