Challenging the Supply-side Vision of the Long Run
Edited by Mark Setterfield
Chapter 4: Growth and Fluctuations in the USA: A Demand-Oriented Explanation
H. Sonmez Atesoglu1 INTRODUCTION This chapter provides a demand-oriented explanation of growth and fluctuations in aggregate output in the USA. Empirical cointegration and vector error correction models are developed using quarterly data. Findings reveal that investment, government spending, exports and the money supply determine the time path of output. These results suggest that there is bidirectional causality among output, investment and the money supply, and unidirectional causality running from government spending and exports to output, investment and the money supply. In recent years, there has been a growing emphasis on the role of supplyside factors, such as technology shocks, in accounting for growth and fluctuations in aggregate output. In neoclassical macroeconomic theory, the possibility that aggregate demand and the money supply have long-term effects on output is generally ignored. Indeed, in some versions of the neoclassical approach, such as the new classical rational expectations models, not even short-term aggregate demand effects on output are allowed for.2 The neoclassical Ôendogenous growthÕ theory recognizes, in addition to technological change, the crucial role of investment in explaining economic growth (see for example, Romer, 1986). The simpler neoclassical growth models of the Feder (1983) type allow exports and government spending a crucial role in determining economic growth.3 But in these neoclassical growth models, there is no room for either aggregate demand or (and in particular) the money supply in determining economic growth. The empirical evidence reported below in favour of the demand-oriented explanation of output, which allows the money supply to interact with investment,...
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