Demand-led growth

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[1] Introduction

Demand led growth is a macroeconomic growth theory proposed by John Maynard Keynes it is built upon the theory of effective demand , this proposes that in the short run economic output is strongly influenced by aggregate demand (government spending + net exports + domestic consumption + investment ). This is because the economy has spare capacity. In short demand led growth is built upon the theory that [2] "Demand creates its own supply".

Uses of Demand-led growth

[3]Both monetary policy and fiscal policy are built upon the demand led growth theory as they both aim to increase aggregate demand in order to increase economic growth. Using the demand led growth theory to pull an economy out of a recession Keynes said that when companies don’t want to invest and consumers don’t want to spend the government must break the dangerous cycle. Keynes stated that reducing interest rates (Reflationary monetary policy) in recession will increase demand hence increase economic growth. But when rates are at the “lower bound” of zero, central banks have very little power e.g. a further decrease in interest rates will not increase aggregate demand, however fiscal policy (taxes and spending) becomes very effective as a fix for inadequate demand. Governments can raise spending to stimulate demand without having to worry about crowding out private investment this is because there is spare capacity, and government spending won’t increase interest rates.[4]

Alternative theory

[5][6][7]

Classical economist view

Classical economists believe in “Says law” this is the belief that supply creates its own demand. The justification of this is that income that the production of the goods provides is enough to purchase the goods it creates. Classical economic view is that the aggregate supply curve is vertical hence any increase in AD will be purely inflationary and cause no increase in economic output, this theory is the total opposite to the demand-led growth theory. Classical economists state the only way for economic growth to occur is for aggregate supply to increase which intern will raise aggregate demand. They state markets regulate themselves and that the government should not intervene with them by using expansionary fiscal policy for example otherwise recessions will become worse.

Kaldororian view

Disequilibrium growth theory.

[8] [9][10]The Kaldorian view consists of 3 laws of economic growth.

  1. There is a close relationship between manufacturing and economic growth
  2. There is a Strong relationship between the growth of industrial productivity and industrial output causing higher returns in other sectors.
  3. There is a Close relationship between aggregate productivity growth and the growth of manufacturing.

The Kaldor view is that ceteris paribus if the manufacturing industry increases in size economic growth will occur. Hence rather than fiscal policy for example encouraging capital accumulation would be more effective at increasing economic growth

References

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