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The accelerator theory is a key economic concept that is used to predict economic growth and development. This theory is based on the idea that consumer confidence and high demand for goods and services have a multiplying effect on the economy. Stimulating demand and confidence can accelerate economic growth, which leads to a continued cycle of greater demand, investment and future growth. The accelerator theory serves as an important tool for economists and politicians hoping to set effective economic growth strategies and policies.
American Thomas Nixon Carver and Bulgarian Albert Aftalion each proposed a version of the accelerator theory during the early part of the 20th century. While this theory pre-dates Keynesian economics, it does fit in with the market principles that make up the heart of Keynesian economic theory. Both Carver and Aftalion predicted that any policy which increased aggregate demand and investment would have a far-reaching effect. Not only would this type of policy spur short-term spending, but it would also impact long-term growth and spending through a multiplier effect.
For an example of how accelerator theory works, consider a scenario where the government lowers interest rates within a country. The lower rates may encourage businesses to invest in new equipment and machinery, as these things now seem more affordable to the business. The company will need to hire new workers to make and operate these machines, and to work in the new factory. This means that workers have more disposable income, which leads to an increase in aggregate demand. This illustrates the initial short-term benefits of a policy aimed at economic growth, but also leads to even greater economic growth over time thanks to the accelerator theory.
The increase in aggregate demand means that people want to purchase more goods and services. Rational, profit-seeking corporations will respond to this increase in aggregate demand by expanding supply in order to meet demand. In order to expand supply, the firm may need to invest in even more machinery and equipment. This type of investment means another cycle of hiring, and more disposable income in the hands of consumers.
Most economists predict that the accelerator theory also works in reverse. If consumer confidence or aggregate demand take a hit due to poor planning or an economic downturn, companies will be unlikely to invest in new equipment or workers. This results in a decline in disposable income, and an even greater hit to aggregate demand.