More on Balanced Growth

In the 1930's, with the Great Depression ongoing, some economists didn't see balanced growth as a realistic possibility. They felt that aggregate demand would fall behind on account of "secular stagnation." "Secular," in this case, means that the stagnation was seen as being beyond the control of government policy and a result of such historical processes as the close of the frontier and the slowing of population growth. The "Secular Stagnation" group thought that profitable investment opportunities had been exhausted, so that declining investment would be inevitable, and that autonomous consumption would also fail to keep up with productive capacity. The only hope they saw for recovery was in the unbalanced growth of government spending.

In the third quarter of the twentieth century, though, conditions were much improved, and a more optimistic view of balanced growth found favor. The Monetarist school of thought believed (as their name implied) that the supply of money is the most important determinant of aggregate demand. Thus, Monetarists advocated a rule of slow but steady growth in the money supply. Their idea was that the supply of money should grow each year at a rate about equal to the average long run growth rate of production. With the money supply growing proportionately with production, they felt that demand would keep pace with supply and the price level could remain stable, without deflation.

The evidence seems to favor the Monetarist school on this issue. We know that, in the period since World War II, deflation has not been a problem -- the price level problem has been inflation. Thus, it seems clear that autonomous spending and demand have been able to keep pace with supply. In the 1990's a few economists in the Monetarist tradition have suggested that there might be something to "secular stagnation," but they were thinking of stagnation in supply, not in demand.

In fact, slower growth of Aggregate Supply is widely seen as one major cause of our imbalance in recent decades. This leads to the idea of a Supply Side economic policy: could the government direct its policies so as to encourage faster growth of Aggregate Supply? That has been a key issue in U. S. national politics for two decades now, and as I write this page (8-13-96) the Republican candidate for president, Robert Dole, has committed himself to a new Supply Side policy and has named a prominent supporter of that kind of policy, Jack Kemp, as his vice-presidential running mate. This suggests a key test for the AS/AD model. Can the model help us to think carefully about Supply Side Policies?

Let's give it a try.

Supply Side