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Edited by Mark Setterfield
Chapter 10: The Endogenous Nature of the ‘Natural’ Rate of Growth
10 The endogenous nature of the “natural” rate of growth Miguel A. León-Ledesma and Matteo Lanzafame 1 Introduction Traditional growth models along neoclassical lines are built around the presumption that fluctuations do not affect the steady state equilibrium of the economy. These models define a rational expectations equilibrium that is achieved through a transitional dynamics path which is independent of any shocks that affect the economy. In its more standard version, initial conditions do not affect the equilibrium either. The view that the “actual” rate of growth can affect the “natural” or potential output growth rate, challenges these assumptions. This view implies that some large and persistent shocks during the transition towards equilibrium can move the equilibrium itself, hence inducing a relation between short-run fluctuations and long-run growth. This proposition was articulated by León-Ledesma and Thirlwall (2002a) (LLT hereafter), who provide evidence on the sensitivity of a statistically defined “natural” rate of growth to economic fluctuations. The intuition behind this approach encapsulates many existing ideas about growth through cumulative causation.1 It contrasts with traditional real business cycle theories and also Keynesian and new-Keynesian theories, which view long-run trends and short-run fluctuations as separate phenomena. In this chapter we review the literature on the endogeneity of the natural rate of growth. The aim is, on the one hand, to survey the empirical evidence to date. On the other hand, we want to discuss the theoretical mechanisms that could link growth and fluctuations, with a view to emphasizing recent developments...
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