Readers Question: Why are demand side policies thought to be ineffective in raising Britain’s long-term rate of economic growth?
The long term rate of economic growth depends upon the growth of productive capacity – the growth of Aggregate Supply. This is determined by supply side factors such as levels of infrastructure, labour productivity e.t.c
Long Run Trend Rate of economic growth is another name for this concept.
If there is spare capacity in the economy then an increase in aggregate demand (through demand side policies like monetary and fiscal policy) will increase economic growth. However, if we persist with demand side policies and try to increase growth above the long run trend rate we will get inflation and the growth will be unsustainable. It will cause a boom and bust situation.
Increasing AD Causes inflation at full capacity.
Long Term Economic Growth Requires Increase in AS.
This growth of AS determines the long run trend rate of economic growth.
However, it is possible that demand side policies could influence the long run trend rate.
If an economy remains in a persistent depression, if demand is constantly weak this can start to affect productive capacity and levels of investment.
Since Japan’s economic crisis in 1989, the sluggish nature of domestic demand has been a factor in reducing the long run economic growth of Japan. Recessions can lead to a fall in not just temporary output but also long term output.