Demand effects in the long run

11 Nov, 2019 at 11:56 | Posted in Economics | Comments Off on Demand effects in the long run

In the standard mainstream economic analysis — take a quick look in e.g. Mankiw’s or Krugman’s textbooks — a demand expansion may very well raise measured productivity in the short run. But in the long run, expansionary demand policy measures cannot lead to sustained higher productivity and output levels.

verdoIn some non-standard heterodox analyses, however, labour productivity growth is often described as a function of output growth. The rate of technical progress varies directly with the rate of growth according to the Verdoorn law. Growth and productivity are in this view highly demand-determined, not only in the short run but also in the long run.

Given that the Verdoorn law is operative, expansionary economic policies actually may lead to increases in productivity and growth. Living in a world permeated by genuine Keynes-type uncertainty, we can, of course, not with any greater precision forecast how great those effects would be.

So, the nodal point is — has the Verdoorn Law been validated or not in empirical studies?

60274818There have been hundreds of studies that have tried to answer that question, and as could be imagined, the answers differ. The law has been investigated with different econometric methods (IV, ECM, cointegration, etc.). The statistical and econometric problems are enormous (especially when it comes to the question on the direction of causality). Given this, however, most studies on the country level do confirm that the Verdoorn law holds.

Conclusion: demand policy measures most probably have long-run effects.

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