This post discusses why monetary and fiscal policy require certain economic conditions to be present if they are to be successful in raising real GDP. In this article I explain the interaction of monetary and fiscal policy inside an aggregate economy framework which can be visualised in 3 dimensions. This 3D shape morphs over time and its shape is very much influenced by 'demand-side' government and central bank policy. I will however hopefully explain how it is 'supply-side' economics which is, at this present time, more important than the demand-side.
Money and debt
First, a short explainer on money and debt since it is important to understand how the expansion of money and credit in the economy does not necessarily create demand. In this section we discuss the 'money supply' which acts as potential demand in the economy. This is 'demand-side' economics.
Let's run through some examples of the creation of debt to see what impact each has on demand.
If my son borrows £10 from me, this does not increase the money supply but it may lead to an increase in current demand versus saving. Since no new money has been created (unfortunately it's not within my powers to create money), only a transfer of assets, the money supply remains constant. If I was going to spend the £10, it does not increase demand in the economy since my son spends the money but I need to defer my spending of that £10 until it is returned to me.... (More)