Long Run Trend Rate of Growth

The long run trend rate of growth is the average sustainable rate of economic growth over a period of time. It could also be termed as the ‘underlying trend rate of economic growth’ The long run trend rate is determined by growth in productive capacity. It is the rate of growth which is consistent with low inflation.

Actual growth can be quite volatile with booms and busts taking the growth rate away from this underlying trend rate. In the UK, in the post war period, the long run trend rate is approximately 2.5% – but we had many periods of boom and bust.

Graph Showing Long Run Trend Rate

This graph shows the actual growth rate is fluctuating above and below the long run trend rate.

  • If growth is above the long run trend rate we say there is a positive output gap (inflationary pressures – boom)
  • If growth is below the long run trend rate, this creates a negative output gap (spare capacity or bust)

Economic Growth Rates and Long Run Trend Rate

economic-growth

This graph also gives an indication of the underlying trend rate. The average quarterly growth rate is around 0.6 – 0.7%. (annual growth rate of 2.5%) In the late 1980s, we had growth well above the underlying trend, rate – but this led to recession of 1990-1991

growth

 

What Determines the Long Run Trend Rate of Growth?

long-run

Graph showing increase in LRAS and AD.

The long run trend rate of growth is essentially determined by the growth in productive capacity – the growth in Long Run Aggregate Supply. The long run trend rate will be determined by factors such as:

  • Technological improvements
  • Labour productivity
  • Investment levels and efficiency of investment
  • Scope for productivity gains from privatisation
  • Labour market flexibility.
  • Levels and quality of infrastructure – communication / transport.

Some countries like China may have a high long run trend rate because their productive capacity is increasing at a faster rate than in UK.

Boom and Bust Cycles

If the actual growth is above the long run trend rate, then it implies that demand is exceeding the growth of productive capacity. In this case, we tend to get inflation and a worsening of the current account. This inflationary growth tends to be unsustainable and is often followed by an economic downturn.

inflation
inflation from increase in AD.

 

Economic Growth Well Below the Long Run Trend Rate

inflation
In 2008-12, we have had an experience of economic growth being persistently below the long run trend rate. In other words actual growth hasn’t caught up with the trend rate.

real gdp and trend

The prolonged recession of 2008-12 caused GDP growth to fall well below the long run trend rate. (What is the UK’s output gap?)

If growth is consistently below the long run trend rate, it may cause the long run trend rate to decrease. In other words, in a serious recession, demand side conditions can have an effect on the average growth and lead to a persistent decline in productivity growth.

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5 Responses to Long Run Trend Rate of Growth

  1. tendo deborah October 17, 2012 at 7:15 am #

    thanx big!

  2. beatrice October 17, 2012 at 10:34 pm #

    thanks alot, you are of help

  3. ochieng simon October 19, 2012 at 9:56 am #

    other determinants of the long run trend of rate of growth are ; capital accumulation; growth-compartible institutions; resources availability ; technological sophistication and entrepreneural capacity.

  4. Monirath January 15, 2013 at 10:25 pm #

    You are the best!

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