1. Population Economics Fall 2012 Economic Growth and the Long Run Rate of Return on Equities

2. Short Run Rate of Return rr S = g P + D/P Where g P equals appreciation And D/P equals rate of cash returns

3. We can calculate the short run rate of return as follows g P = g P/E + g E And D/P = (D/E) / (P/E) So short run rate of return is: rr S = g P/E + g E +(D/E) / (P/E)

4. A numerical example rr S = g P/E + g E +(D/E) / (P/E) rr S = 1.5% + 3.5% + 50%/25 rr S = 1.5% + 3.5% + 2% rr S = 5% + 2% = 7%

5. Long Run Rate of Return rr S = g P/E + g E +(D/E) / (P/E) In the long run g P/E =0 and g E = g Y So rr L = g Y +(D/E) / (P/E)

6. A numerical example using SS growth assumptions rr L = g Y +(D/E) / (P/E) rr L = 1.5% +(50%) / (25) rr L = 1.5% +2% rr L = 3.5%

7. There is no advantage to investment in equities Given the long term growth rate of GDP assumed by the SS Trustees, (1.5%) Equities will return only 3.5% and not do any better than holding long term government bonds.

8. The End