The balance of payments-constrained growth rate and the natural rate of growth: new empirical evidence

Abstract

This paper implements a panel approach to investigate the empirical relevance of ‘Thirlwall’s law‘, which states that long-run growth must be consistent with balance of payments (BOP) equilibrium and is thus determined on the demand side. Building on autoregressive distributed lag modelling, mean-group and pooled mean-group estimation methods, we use annual data over the 1960–2010 period for a panel of 22 OECD countries and find significant support for the ‘law’. Next, we also explore empirically the hypothesis that the BOP-constrained growth rate (yB) must equal the natural (or potential) rate of growth (yN) and find that the data do not reject this hypothesis. Finally, we adopt a new approach, based on panel Granger causality methods, to explore the direction of causality between yB and yN. The results indicate the existence of unidirectional long-run causality from yB to yN, thus reinforcing the view, embodied in the law that long-run growth is determined by demand and constrained by the BOP.

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