The Korean Journal of Economic Studies
A Study on the Relationship Between Aggregate Demand and Long-run Growth
Geunhyung Yim (The Bank of Korea)Year 2017Vol. 65No. 3

Korean economy is now showing a new growth pattern. Negative GDP gap continues for years and potential GDP growth rate is decreasing at a speed close to that of actual GDP growth rate. But these phenomena are hard to be explained by the “conventional view” that supply factors determine long-run economic growth. On these backgrounds, this paper surveys the theoretical literature on the relationship between demand and economic growth, assesses the current low growth trend of the global economy, and conducts an econometric analysis using Korean data to see whether aggregate demand can affect long-run economic growth. The analysis focuses on changes in the link between aggregate demand and aggregate supply. Demand-led growth theory, developing with effective demand theory and aggregate demand approach as its two pillars, implies that deficiency of demand may be one of causes of recent sluggish global economic growth. The labor income share has decreased since the 1980s, a shortage of investment has been chronic, and inflation remains low despite of a decline in potential GDP. Moreover, empirical analysis, which adopts Bashar (2011, 2012)’s identification methodology, indicates that aggregate demand shocks have a permanent impact on the long-run economic growth of Korea. The result also shows that such relationship has been intensified after 2012.