Effective Demand and Path Dependence in Short- and Long-Run Growth

Abstract

It is a common practice in mainstream neoclassical economics to bypass awkward problems by assuming they are transient, basically temporary failure of the price mechanism in the ‘short run’ that gets resolved in the ‘long run’. Depending on the context this might mean different things, for example, slow speed of adjustment to equilibrium like in some older theories of frictional unemployment or in some modern search theories of unemployment. It might mean deficient learning in the short run that gets remedied in the long run, that is, people are wiser in the long run (even if dead!). It was captured by Milton Friedman’s famous quip against money illusion, ‘you cannot fool all the people all the time’. This view became an obsession with later Chicago monetarists who argued that money is neutral in the long run as enough information becomes available; continuous market clearing ‘rational expectations’ is only a short step from it on the assumption that the market most efficiently processes all the available information implying that market generated prices provide the best guidance.