RDP 9507: Macroeconomic Policies and Growth 5. Conclusions

The industrial world achieved an impressive improvement in long-run growth in the first generation after World War II. Since then growth has been slower, though it remains significantly above the rates recorded in the first half of this century. This slowdown renewed interest in the determinants of long-run growth and the last decade has witnessed an explosion in both theoretical and empirical studies of growth. Several analysts have also examined whether there is a role for macroeconomic policies in explaining the growth performance of the 1950–73 period, the subsequent slowdown and in improving the prospects for future growth.

This paper has reviewed this new literature, looking at both theoretical and empirical aspects that may have implications for the design of macroeconomic policies. The evidence reported is, to some extent, selective and tentative. Furthermore, since the principal determinants of growth are factor accumulation and technological progress, the impact of macro-policies is probably at the margin. Nevertheless, on balance, we conclude that macro-policies do make some difference to long-run growth. We draw the following five broad conclusions from our study.

First, although both neoclassical and endogenous growth models assign a major role to capital accumulation, policy measures to boost aggregate investment through special incentives do not seem to be called for. There is little evidence that aggregate investment yields excess returns, suggesting that the positive externalities postulated in some versions of endogenous growth theory are very small at an economy-wide level. Consequently, the main tasks of policy makers in this area are to remove existing distortions (especially those favouring investment in property) and to abstain from reducing public investment in infrastructure merely as a means of restoring fiscal balance.

Second, in a world of liberalised capital flows, saving acts as a constraint on investment and growth for the world as a whole but less so for an individual country, as capital flows from countries with excess saving to those where profitable investment exceeds domestic saving. Yet, reliance on foreign saving is not costless as countries with growing external liabilities face higher real interest rates, a depreciating real exchange rate, and perhaps, a higher degree of economic uncertainty. Ultimately, capital inflows are limited to the rate the market accepts as sustainable, which for a country like Australia, with abundant natural resources and a stable political environment, may be higher than for many other capital importing countries.

Third, in many industrial countries, declining national saving rates are primarily a consequence of lower government saving, suggesting the need for reduced fiscal imbalances. In Australia, private savings have also fallen substantially, suggesting a role for specific incentives to boost this component of savings. There is also some evidence that the causation between higher national saving and faster growth may run both ways. While many cross-country regressions identify the saving rate as one of the principal growth determinants, several recent studies suggest that faster growth also leads, with some lag, to a higher saving rate.

Fourth, recent evidence suggests that when economies are near potential output, the short-run trade-off between inflation and the output gap is asymmetric, with short-run rises in output being more inflationary than falls in output are disinflationary. If this is the case, it opens a channel by which macro-policy can influence the level of long-run output. This has two implications. The first is that a policy strategy that acts pre-emptively to counter expected future demand pressures and quickly mitigates the effects of unexpected shocks has a positive effect on the level of output, compared with a more hesitant approach which acts only when the demand pressures have appeared. Second, provided inflation is kept close to its target in the medium-term, policy which tolerates some short -term deviations of inflation from its target can reduce fluctuations in real output and thereby generate a higher long-run output level than a policy with the sole goal of keeping inflation close to its target.

Fifth, because monetary policy determines inflation in the long run, a key role of monetary policy in influencing growth depends on the relationship between inflation and growth. Although most economists believe even moderate rates of inflation adversely affect growth, unambiguous evidence has been difficult to come by. While there is still professional disagreement on the robustness of the empirical evidence, it does appear that higher inflation, and the associated increased uncertainty about future inflation, adversely affects growth in the industrial countries. Moreover, the gains from lower inflation appear to exceed the initial costs of reducing inflation within about a decade.