In economics, dynamic efficiency is a situation where it is impossible to make one generation better off without making any other generation worse off. It is closely related to the notion of "golden rule of saving".
Are modern economies dynamically efficient?
Abel, Mankiw, Summers, and Zeckhauser (1989) develop a criterion for addressing dynamic efficiency and apply this model to the United States and other OECD countries, suggesting that these countries are indeed dynamically efficient.
In the Solow growth model
An economy in the
Solow growth model Solow is a surname. Notable people with the surname include:
* Alan Solow, an American lawyer and Jewish leader
* Herbert Solow (journalist) (1903–1964), an American journalist
* Herbert Franklin Solow (1931–2020), an American producer, direct ...
is dynamically inefficient if the savings rate exceeds the
Golden Rule savings rate. If the savings rate is greater than the Golden Rule savings rate, a decrease in savings rate will increase consumption per effective unit of labor. A savings rate higher than the Golden Rule savings rate implies that an economy could be better off today and tomorrow by saving less.
In other models
The
Ramsey-Cass-Koopmans model does not have dynamic efficiency problems because agents discount the future at some rate β which is less than 1, and their savings rate is endogenous.
The
Diamond growth model is not necessarily dynamically efficient because of the overlapping generation setup. In a competitive equilibrium, the growth rate may exceed the interest rate, which entails dynamic inefficiency. This is because agents are finitely lived. However, competitive allocations are dynamically efficient if one augments the Diamond model with
land
Land, also known as dry land, ground, or earth, is the solid terrestrial surface of the planet Earth that is not submerged by the ocean or other bodies of water. It makes up 29% of Earth's surface and includes the continents and various isl ...
as an additional factor of production.
[ Stefan Homburg (1991) Interest and Growth in an Economy with Land]
''Canadian Journal of Economics 24''
pp. 450-459.
Notes
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Welfare economics