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Investment, Growth and the Natural Rate of Interest

Carr, Douglas, Investment, Growth and the Natural Rate of Interest – How the Marginal Product of Capital Explains (Almost) Everything (June 13, 2014). Available at SSRN:

An Investment-Growth model is developed based upon generalized conditions that an economy’s participants: 1) act to maximize economic growth, and 2) are indifferent at the margin between consumption and investment. With these conditions, the productivity of capital equals the rate of investment. An economy’s growth rate thus equals the square of its investment rate after adjusting for depreciation. In a cross section analysis of a panel of advanced OECD economies, proxy growth rates from the Investment-Growth model explained over 70% of the variation in growth rates among panel countries. The impact on the productivity of capital from production factors other than capital may account for the model’s significant explanatory power despite its simple specification. The Investment-Growth model produces a measure of the incremental impact on growth from incremental capital investment. Incremental return to capital then mirrors incremental capital productivity, and the combination of these factors produces a proxy for the natural rate of interest. This proxy, relying on the marginal productivity of capital, produces estimates of real and nominal interest rates that correspond to the range of Fed Funds and T-Bill rates in the U.S. from 1962 to the present. The Investment-Growth model may provide a framework for analyzing impact on growth of other production factors or from government policies by assessing their impact upon the level of investment and productivity of capital.”

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