A new demand-restricted growth theory

Mainstream growth theory is dominated by variations of the neoclassical approach. Growth is explained fully by elements of the supply side. In this paper we examine the general mechanism of technology growth and capital accumulation. However, instead of following the supply-side driven neoclassical approach, we suggest a demand-restricted growth process. We refer to this mechanism as the Keynesian growth process, obtained by suggesting an unconventional equilibrium concept in a stochastic environment. We define macroeconomic equilibrium as stationary no-expectation-error equilibrium. While the standard equilibrium concept is related to aggregate market clearing, the suggested no-expectation-error equilibrium is related to the Nash idea of individual stationary behavior. Even if no rigidities are introduced, steady-state growth is demand-restricted and below the neoclassical growth path. Policy implications of the Keynesian growth mechanism strongly contrast with neoclassical implications. We also argue that empirical analysis should determine which approach is the relevant one at each given time.

Mainstream growth theory is dominated by the neoclassical notion of long term full-employment equilibrium growth. Hence, growth is explained fully by elements of the supply side, namely technology growth and capital accumulation. Say’'s law and the notion of 'savings determine investments and capital accumulation' ’is the fundamental ingredient of all these models. In this new Keynesian growth model, however, we depart from this neoclassical notion by substituting the "“allocation equilibrium concept of Say'’s Law”" (no excess-supply in the aggregate market) by the concept of a stationary "“no-expectation-error equilibrium"”. While Say’'s law is related to aggregate market clearing as an equilibrium concept, the suggested “"stationary no-expectation-error equilibrium" ”is related to the Nash-idea of individual stationary behavior. As a result, effective income can remain consistently below potential income and the stationary earnings ratio is less than one. The level of this steady-state earnings ratio is determined by the well known Keynesian income-expenditure multiplier and other demand-side elements. As a result policy implications of this long-term Keynesian growth mechanism contrast strongly with neoclassical implications. For example, in this model a reduction in the share of labor income and a respective reduction in the consumption rate reduces the economy'’s steady state position and growth path In contrast, in a neoclassical model, a respective increase in the share of capital income and the savings rate improves steady state and the level of the growth path.