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

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 (y (B) ) must equal the natural (or potential) rate of growth (y (N) ) 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 y (B) and y (N) . The results indicate the existence of unidirectional long-run causality from y (B) to y (N) , thus reinforcing the view, embodied in the law that long-run growth is determined by demand and constrained by the BOP.