3.6 Policy implications
The model in this chapter has interesting policy implications as to what a government could do to limit the occurrence or length of recessions and thereby increase average growth over time.
First, on a more structural front, generalizing the access to investment opportunities (or making workers become shareholders of firms) would make it more likely that aggregate savings be fully invested in the high-yield production activity. Similarly, allowing for foreign direct investment (i.e. for additional foreign wealth to be invested in new equity) would increase the borrowing capacity of investors as a whole, thereby again making it more likely that domestic savings be more fully invested in the high-yield production technology.Second, for a given division of the economy between savers and investors, properly designed countercyclical transfer policies will also be growth-enhancing. More specifically, suppose that the economy is currently in a slump, so that the investment capacity of entrepreneurs μWB is less than aggregate savings St = WB + Wf (i.e. qt > 1). Then, in order to achieve the Harrod-Domar rate of growth g, it suffices to redistribute wealth Δ W from savers to entrepreneurs, where
Such policy will ensure that all savings are invested in the high- yield production activity, so that indeed the growth rate of the economy is equal to
Note first that this redistribution policy need not hurt the savers: By raising investment capacity it also raises the demand for loanable funds and therefore the equilibrium interest rate from its depressed value 02 to its high value σι = βσ. Thus, the interest income of savers moves from σ2Wf to σι(Wf — ΔW) which is higher if the required wealth transfer ΔW is sufficiently small.
This will be the case whenever the upcoming recession is not too severe. Moreover, if the wage rate has an efficiency wage component, so that employed workers earn positive rents, the wealth transferΔW can benefit workers due to its expansionary effects on the labor market.
Next, the above type of transfers can be achieved through a standard countercyclical fiscal policy: since slumps are periods with idle savings, governments can promote recovery by issuing public debt in order to absorb those idle savings and thereby finance investment subsidies (or tax cuts) for businesses. More specifically, at the beginning of a recession period t + 1 (where therefore qt > 1), the government should issue new public debt ΔB and use the proceeds to finance investment subsidies or tax cuts for entrepreneurs. The government must of course offer an interest rate on its new bonds which is at least equal to the rate of return on the low-yield home activity σ2 in order for such bonds to be subscribed by savers. Public debt repayment at the end of the period is financed through tax revenues of an amount equal to ΔT = σ2ΔB and raised on labor income or interest income. Such a countercyclical fiscal policy amounts to a direct transfer ΔW = ΔB from savers to entrepreneurs. We thus obtain a new rationale for countercyclical budgetary policies, in addition to the one pointed out in the previous chapter.