An Intertemporal Model of Saving and Investment

39 Pages Posted: 20 Dec 2001 Last revised: 31 Dec 2001

See all articles by Andrew B. Abel

Andrew B. Abel

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peter G. Peterson Institute for International Economics

Date Written: April 1982

Abstract

The standard model of optimal growth, interpreted as a model of a market economy with infinitely long-lived agents, does not allow separation of the savings decisions of agents from the investment decisions of firms. Investment is essentially passive: the "one good" assumption leads to a perfectly elastic investment supply; the absence of installation costs for investment leads to a perfectly elastic investment demand. On the other hand, the standard model of temporary equilibrium used in macroeconomics characterizes both the savings-consumption decision and the investment decision, or, equivalently, derives a well-behaved aggregate demand which, in equilibrium, must be equal to aggregate supply. Often, however, we want to study the movement of the temporary equilibrium over time in response to a particular shock or policy. The discrepancy between the treatment of investment in the two models makes imbedding the temporary equilibrium model in the growth model difficult. This paper characterizes the dynamic behavior of the optimal growth model with adjustment costs. It shows the similarity between the temporary equilibrium of the corresponding market economy and the short-run equilibrium of standard macroeconomic models: consumption depends on wealth, investment on Tobin's q. Equilibrium is maintained by the endogenous adjustment of the term structure of interest rates. It then shows how the equivalence can be used to study the dynamic effects of policies; it considers various fiscal policies and exploits their equivalence to technological shifts in the optimal growth problem.

Suggested Citation

Abel, Andrew B. and Blanchard, Olivier J., An Intertemporal Model of Saving and Investment (April 1982). NBER Working Paper No. w0885. Available at SSRN: https://ssrn.com/abstract=294075

Andrew B. Abel (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
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HOME PAGE: http://finance.wharton.upenn.edu/~abel/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Olivier J. Blanchard

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

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