AS Macro Key Term: Trend Growth

Geoff Riley

23rd May 2011

The trend or underlying rate of growth is the long run average rate for a country over a period of time. Measuring the trend requires a long-run series of data to identify the different stages of the economic cycle and then calculate average growth rates from peak to peak or trough to trough.

Another way of thinking about the trend growth rate is to view it as a safe speed limit for the economy. In other words, an estimate of how fast the economy can reasonably be expected to grow over a number of years without creating an increase in inflationary pressure.

Above trend growth – positive output gap: If the economy grows too quickly (much faster than the trend) – then aggregate demand will eventually exceed long-run aggregate supply and lead to a positive output gap emerging (there is excess demand in the economy). This can lead to demand-pull and cost-push inflation.

Below trend growth – negative output gap: If the economy experiences a sustained slowdown or recession (i.e. growth is well below the trend rate) then output will fall short of potential GDP leading to a negative output gap. The result is downward pressure on prices and rising unemployment because of a lack of aggregate demand.

Potential output depends on the following factors

(1) The growth of the labour force—those people able available and willing to find employment: The British government has invested in a number of schemes designed to raise employment including reforms to the tax and benefit system. Changes in the age structure of the population also affect the total number of people seeking work. And we must also consider the effects that migration of workers into the UK from overseas, including the newly enlarged European Union, can have on our total labour supply.

(2) The growth of the nation’s stock of capital – driven by the level of fixed capital investment.

(3) The trend growth of productivity of labour and capital. For most countries it is what happens to productivity that drives the long-term growth. The causes of improved efficiency come from making markets more competitive and achieving increased output per work within individual plants and factories.

(4) Technological improvements reduce the costs of supplying goods and services which leads to an outward shift in a country’s production possibility frontier

UK productivity growth

United Kingdom from Timetric

Business investment in the UK

Total Investment: Businesses, quarterly, UK from Timetric

Supply-side policies and trend growth

Supply-side policies are mainly micro-economic policies designed to improve the supply-side potential of an economy, make markets and industries operate more efficiently and thereby contribute to a faster underlying rate of growth of real national output

The key supply-side concepts to focus on are incentives, enterprise, technology, mobility, flexibility and efficiency.

1. Improve incentives for people to find work to raise employment and cut unemployment
2. Increase labour and capital productivity
3. Increase the occupational and geographical mobility of labour
4. Increase capital investment and research and development spending by firms
5. Promoting more competition and stimulate a faster pace of invention and innovation
6. Provide a platform for sustained non-inflationary growth of an economy
7. Encourage the start-up and expansion of new businesses

Injecting growth into the economy (BBC news, July 2012)

Geoff Riley

Geoff Riley FRSA has been teaching Economics for over thirty years. He has over twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.

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