Essays in Honour of A.P. Thirlwall
Edited by Philip Arestis, John S.L. McCombie and Roger Vickerman
Chapter 5: Cycles, Aggregate Demand, and Growth
Miguel A. León-Ledesma Introduction Growth theory has focused on the causes of increases in the levels of per capita income from a perspective that assumes that, generally, the business cycle has no role to play. This assumption eliminates any influence of cyclical behaviour stemming from aggregate demand and nominal shocks on the long-run performance of nations. That is, growth theory is a theory of potential output growth. This contrasts with the more policy-oriented and popular view that good macroeconomic management is a pre-condition for healthy and sustainable growth in the long run. The question then arises as to whether demand shocks and other determinants of the business cycle do have a role to play in determining the level of potential output. The relation between cycles and growth is not a new issue in macroeconomics, but revived interest on it arose as a consequence of the development of the endogenous growth models of Romer (1986 and 1990), Lucas (1988) and Aghion and Howitt (1992). Back in the 1960s and 1970s, this relation was also tackled within Keynesian frameworks by authors such as Kaldor (1966 and 1970) and Thirlwall (1979). The Real Business Cycle (RBC) literature, on the other hand, has continued to assume that business cycles do not affect potential output, hence eliminating non-linearities arising in the decomposition of shocks.1 Recently, with the development of new datasets and econometric techniques, authors such as Malley and Muscatelli (1999) and Pedersen (2003) have attempted to unveil statistical relations between cycles and productivity....
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