Macroeconomic Policy, Investment and Innovation

A, perhaps the, major difference between schools of thought in macro-economic analysis arises from the relationship between the demand side and the supply side. Say’s Law is, of course, often summarized as ‘supply creates its own demand’ and the view that the level of economic activity is determined by the supply potential, and that demand has to adjust to underpin that level of supply. There have been long debates over whether this is a feature of the short run as well as the long run. The separation between demand and supply, and the view that there is a predetermined growth of supply, is reflected in the following quote from the now Governor of the Bank of England: ‘if one believes that, in the long-run, there is no trade-off between inflation and output then there is no point in using monetary policy to target output.… [You only have to adhere to] the view that printing money cannot raise long-run productivity growth, in order to believe that inflation rather than output is the only sensible objective of monetary policy in the long-run’ (King, 1997, p. 6). Similar sentiments are often expressed with respect to fiscal policy, and the more general view that the level of demand has no long-run effects on the levels of output and employment in an economy. The vertical aggregate supply curve is a regular feature of macroeconomic analysis, and is an embodiment of the view that the level of economic activity (in the long term) is supply-determined (with the implicit assumption being made that the vertical aggregate supply curve is not influenced by the time path of aggregate demand.