Supply-Side Macroeconomics

Abstract

This paper tests New Classical and Keynesian explanations ofoutput determination within an encompassing "factor utilization"model wherein the output decision by producers is modelled as thechoice of a utilization rate for employed factors. In thisencompassing model, the ratio of actual to normal output (withthe latter defined by a nested CES vintage production functionwith capital, energy and employment as factor inputs) isexplained by unexpected sales (a Keynesian element), abnormalprofitability (one component of which is the Lucas "pricesurprise" effect), and abnormal inventories.Results using Canadian data show that the Keynesian and NewClassical elements contribute explanatory power, as does theproduction-function-based measure of normal output, while each ofthese partial models is strongly rejected in favour of theencompassing model. The highly structured factor utilizationmodel is also seen to fit better than an unstructured VAR model.U.S. data confirm the results, and show that there aresignificant effects from abnormal demand, profitability andinventory levels even if the labour and capital components ofnormal output are defined using hours and utilized capital ratherthan employment and the capital stock. The results are alsoconfirmed using alternative output (and hence input) concepts,using a translog function instead of a CES function to definenormal output, and using data for several other major industrialcountries.