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Economic Growth Theory

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THEORETICAL FRAMEWORK 2.1. Inflation and Economic growth Theoretical discussion From many years ago, the relationship between inflation and growth was a debatable topic among economists. More economic theories were developed by various theorists and schools to explain relationship between inflation and growth. These theories are founded on various study of the phenomenon but no theory gives full explanation. The former inflation-growth theories were built on cyclical observations. The persistent inflation is observed as a post world war II phenomenon (Gokal & Hanif (2004)). During the period of after II world war, the theories suggested a positive relationship between inflation and growth. The Keynesian school of thought raised the same argument. …show more content…

Super neutrality happens in economy when the steady state 's capital stock and consumptions are free from money expansion in long run. His illustration proved that an increase in the capital stock increases consumption and the real value of the stock of cash in two ways; it raises disposable income and its associated stock of real wealth. Hence decreseasing the rate of change of the capital stock, it raises net output and as result, accelerates capital accumulation. His model also shows that an increase in the expected rate of inflation reduces the demand for money; it therefore leads to rise in price level. Sidrauski concluded that there is no relationship between inflation and economic growth, as rises in the inflation rate does not influence the steady state capital stock. Both output and economic growth are not …show more content…

Keynesian Theory The birth of “The general theory of employment, interest and money” in 1936 by Keynes has provided the basis for analyzing modern macroeconomic policies, and is usually referred to as the Keynesianism. Keynes argued that if economy is in recession period, Government could maximize economy (full production and total aggregate demand) through increase in government spending or tax cut to increase investment and consumption. Therefore, government influences through fiscal policies will drive up investment and demand to attain full productions. Keynesianism has been used aggregate demand (AD) and aggregate supply (AS) framework to analyze the relationship between output, inflation and employment. The Keynesian View of the AD/AS Model uses an SRAS curve (see figure1), which is horizontal at levels of output below potential and vertical at potential output. Look at the AD/AS figure, for the potential output (Yp), if AD decreases, output is changed but price is constant while increase in AD affects only prices and output is kept constant. Then economy begins at intersection of AD and SRAS at P0 and Yp, starting from the potential out level (Yp) which presents full employment in economy, thus AD is volatile and can fall easily in the recessionary gap, Therefore economy remains in equilibrium (Y1) but below full employment and Keynes supposed that for certain period, the economy will hold recession gap with targeted rate of

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