U-shaped Paths of Consumption and Physical Capital in Lucas-type Growth Models

This paper considers transitional dynamics of consumption and physical capital in Lucas-type growth models. We find that when the ratio of physical to human capital is sufficiently high, it is optimal for both consumption and physical capital to fall for a finite period and then rise along their transition paths. Endogenous growth models may therefore not be able to generate a sustainable path of development when the steady state coexists with the transitional dynamics. According to the extent of consumption smoothing, we characterize the stages of transition in three different growth regimes. Particularly in the normal and paradoxical cases, dynamics of the Lucas model is contrasted with that of Ramsey.