Assignment: Intermediate Macroeconomic Theory

This assignment is designed to let you demonstrate your understanding of economic growth and your ability to apply the model to real world data.

This project will be using actual data for the U.S. economy to evaluate the Solow model and use it to estimate future changes in the economy. You will be using date from the FRED database maintained by the Federal Reserve Bank of St. Louis.

At the top of the web page you will find a search box. Search for GDPC1 (Real Gross Domestic Product). You be taken to a page with a selection of data bases. Select GDPC1 and click on the "add to graph" option.You should now be on a page with a graph of real GDP from 1947 to the most recent quarter. Take a moment and examine the graph. Placing your cursor over the graph will show the actual data represented. The gray region indicates a recession. What happened to real GDP in the recession? What happened to real GDP during the expansions? Is this what you expected to see?

Now click on the "edit graph" button found in the upper right part of the screen. This opens a table that will let you modify the data in the graph. First, change the frequency of the data to annual using the average aggregation method. Further down on the same page you will find a box to add data. Type POP into this box and select the data set for Total Population: All Ages including Armed Forces Overseas (POP). Click the Add button found to the right. Finally, further down you will find the section for creating a custom formula. In the formula block, type (a*1000)/b and click the Apply button. This formula creates a data set for per capita real GDP. (Note: since RGDP is reported in billions and POP is reported in thousands, we must multiply RGDP by 1000 before dividing by POP.)

Repeat the process three more times for investment (GDPIC1), depreciation (M1TOTL1ES000), and consumption (PCEC). Be sure to click Add Line at the top of the page for each new series.

Now click on the X in the upper right-hand portion of the editing table to close the table.

Take a moment to examine your graph and how the four data sets relate to each other. Do the data show what you expected or are you surprised by anything?

In the upper right-hand corner you will see a button for downloading your data. Select the option to download your data in EXCEL format. Open the EXCEL file and save it.

In your EXCEL file, create a column for the Saving Rate. To calculate this column, divide the investment column by the GDP column.Now create a column for the combined growth in population and growth in labor efficiency, (n + g). Calculate these values as the percentage change in RGDP column.

Finally, you will need four more columns. Create a column for the capital stock per worker by dividing the depreciation column by the rate of depreciation. The second column estimates capital income, MPK x k, by multiplying RGDP by 0.3. (Note: It is assumed that capital income is approximately 30% of RGDP.) The third column estimates the MPK by dividing the capital income column by the capital stock column. Then add a column for the Depreciation Rate. Calculate this column by dividing the depreciation column by the capital stock column.

At this point you have estimated the capital stock, the saving rate, the depreciation rate, the combined population growth rate and efficiency growth rate, and the MPK. You will use this data to do the following.

1. Estimate the steady-state capital stock for each year.

2. Compare your estimated capital stock with the estimated steady-state capital stock. Based on this comparison for each year, would you have predicted the economy would grow or shrink? Explain your prediction. Compare your prediction to the actual real GDP data. Were you correct?

3. Consider the Golden Rule capital stock. Use your estimates for each year to determine if the economy's capital stock was above, below, or about the same as the Golden Rule capital stock. Explain your answer.

4. Based on your estimates, predict what will happen in the coming year. If you were a policy adviser, what recommendations would you make?