ON THE DYNAMIC STABILITY OF ECONOMIC GROWTH: The Neoclassical versus Keynesian Approaches

Abstract

This chapter provides an overview of the dynamic stability of economic growth. Whether or not the dynamic allocation of scarce resources through the market mechanism can achieve stable economic growth is not simply a matter of theoretical interest, but also is indispensable in the consideration of the effects of public policy. However, there are two opposing approaches to the problem of the dynamic stability of the market mechanism: one approach bases its analysis on the neoclassical economic theory and the other approach considers the problem within the framework developed in Keynes'General Theory. The approach based on neoclassical theory concludes that the process of market growth is usually stable, and, but for exceptional situations, prices change stably and full-employment growth obtains. Keynesian theory, on the other hand, comes to the conclusion that the market allocation of scarce resources is an inherent cause of instability in a modern capitalistic system and that maintaining stable economic growth is akin to walking on the edge of a knife. The chapter reviews the kind of assumptions on which these two conclusions concerning the stability of the growth process in a market economy are based, and also describes some of the more fundamental differences between the neoclassical and Keynesian approaches. It further highlights the basic assumptions of the neoclassical growth theory. The neoclassical theory of economic growth was first formulated in the works of Tobin, Solow, and Swan. Although the theoretical background is much older and may be traced back to the early works of Jevons, Menger, and Walras, the models of Tobin, Solow, and Swan have put the neoclassical theory into an even clearer form, and at the same time, the limitations of the neoclassical framework have been more explicitly brought out.