FMM Working Paper

: Three Principles for Demand-Led Growth

This article proposes three necessary and sufficient principles as a foundation for the claim that the dynamic path of aggregate demand is the primary determinant of economic growth beyond the short run. (1) Demand drives production and employment. (2) Neither endogenous nominal adjustment nor wise monetary policy reliably restores aggregate demand to a level consistent with full employment. (3) Endogenous responses of labor productivity and labor force growth to the state of the economy cause aggregate supply to accommodate the long-run path of aggregate demand. Together, these principles imply there is neither a long-run growth rate nor an equilibrium "natural" unemployment rate determined independently from the dynamics of aggregate demand. Instead, demand growth is the primary determinant or economic growth beyond the short run and the equilibrium unemployment rate adjusts to allow supply to accommodate the demand path (subject to a constraint imposed by a minimum unemployment rate). The article also summarizes historical and statistical evidence consistent with the three principles.

Keywords: aggregate demand, aggregate supply, economic growth, unemployment rate