Persistent Effects of Autonomous Demand Expansions

Abstract

The prevailing wisdom that aggregate demand shocks determine short-run cyclical fluctuations around a supply-determined equilibrium growth rate and an associated equilibrium unemployment rate (or NAIRU) has been called into question by various strands of literature over the last few decades. Specifically, a recently revived literature on hysteresis finds significant persistence in the effects of negative aggregate demand shocks (e.g.

The Secular Stagnation of Productivity Growth

“…Higher wage growth may raise inflation considerably less than expected, in other words, because the rate of potential growth goes up in response to the increases in productivity, demand and actual output induced by the extra wage growth (see Figure 2; Storm and Naastepad 2012;Storm 2018;Girardi et al 2018;Fontanari et al 2019). If so, the reverse holds true as well: sluggish business investment in the U.S. has been a key factor behind the stagnation of TFP growth and has also been responsible for propagating hysteresis-like adverse consequences for TFP and potential output after 2008 (see Hall 2014;Ollivaud et al 2016;Fazzari et al 2017;Cynamon and Fazzari 2017;Girardi et al 2018). This conclusion only becomes stronger once we acknowledge the 'cumulative causation' at work: sluggish investment weakens aggregate demand and this, in turn, weakens accumulation through the 'accelerator effect' -which was Nicholas Kaldor's argument -as well as real wage growth, which reduces the rate of labor-saving technological progress (as argued here).…”

“…However, the problem with this simple 'intuition' is that it is wrong. There are sound theoretical reasons, and there is robust empirical evidence, to blame (a substantial part of) the long-run decline in productivity growth on stalling demand growth (Storm 2017;Girardi, Paternesi Meloni and Stirati 2018;Fontanari et al 2019). This goes against a deeprooted theoretical belief system which maintains that long-run trend growth, which is argued to be determined by the supply-side factors 'technology' and 'demography', can be completely separated from short-run fluctuations of actual growth around this trend, which are held to be due to changes in demand.…”

“…This goes against a deeprooted theoretical belief system which maintains that long-run trend growth, which is argued to be determined by the supply-side factors 'technology' and 'demography', can be completely separated from short-run fluctuations of actual growth around this trend, which are held to be due to changes in demand. It is this belief system -that 'Keynes' holds only for the short run, whereas the inexorable supply-side factors 'demography' and 'technology' govern the long-run, and on which macroeconomics has built its notions of 'potential output' and 'output gaps', which are widely employed to anchor macro-economic, and especially monetary, policy (Fatás 2018) -which has to be radically rethought (Girardi et al 2018;Fontanari et al 2019).…”

“…What must be recognized is that structurally weak demand growth forces down potential growth, whereas faster demand growth, supported by more expansionary, full-employment oriented fiscal and monetary policies, raises productivity growth and potential output. Conventional (supply-side) measures of potential output which ignore the dynamic demand-side channels, systematically overemphasize the 'inflation barrier' and methodically underestimate the margins for expansion of actual output (Fontanari et al 2019) and thereby legitimate a structural deflationary bias in macro policy (Storm and Naastepad 2012;Girardi et al 2018;Storm 2017). What is not recognized is that higher demand may gradually remove the scarcities and bottlenecks which in the short run might create inflation pressures.…”

“…The important dynamic macro channels through which demand growth influences potential output growth, listed in Figure 2, deserve more attention in research. 6 After all, it is 6 Key studies on these channels include Storm and Naastepad (2012), DeLong and Summers (2012), Hall (2014), Fazzari et al (2017), Storm (2017), Girardi et al (2018), Taylor et al (2019) and Fontanari et al (2019). dashed line is union density…”