Whence the assumption that given inadequate demand, the cause is inadequate demand for investment goods? I.e. whence the assumption that demand should be increased by encouraging more lending and investment?
I mean before cutting interest rates, do central banks do detailed surveys of employers’ current use of capital equipment and actually PROVE that not enough of such equipment is being used? Of course not.
Moreover, the idea that central bank staff know more about the optimum amount of capital equipment to use in for example the chemical industry than qualified chemical engineers with twenty years experience is absurd.
Of course if demand falls to inadequate levels, employers will cut back on investment spending, plus interest rates will fall. But whence the assumption that employers have not cut back on investment spending to an extent that is entirely rational in view of those two factors? The most reasonable assumption is that employers, including chemical engineers, have got their sums right, and hence that no additional and artificial cut in interest rates is needed.
I.e. the most reasonable assumption is that given an increase in demand for ALL goods and services, employers will increase investment spending as appropriate.
Provisional conclusion: in case you didn’t already know it, you’re living in la-la land. Or put another way, the emperor has not clothes.
The free market.
With a view to seeing what WOULD BE the best way to increase demand, let’s consider what a perfectly functioning free market would do about inadequate demand, i.e. excess unemployment. Obviously the free market is not always a perfect system: there are certainly specific areas where it goes wrong. But I do have some faith in it. Indeed the economists and politicians who think they know better than free markets turn out to be wrong half the time.
In a totally free market, given excess unemployment, wages and prices would fall. That raises the real value of money (base money in particular). That increased stock of money in real terms encourages more spending. That effect is known as the “Pigou effect” (after the economist Arthur Pigou).
Of course the Pigou effect does not work too well in the real world because (as Keynes righly pointed out) wages are “sticky downwards”. Thus as an alternative (and as I think Keynes pointed out), why not increase the stock of MONEY UNITS (pounds, dollars, etc), rather than try to get the increased stock by increasing the value of each unit?
Increasing the number of units equals helicopter money, which in turn comes to very nearly the same thing as fiscal stimulus funded by new money rather than by government debt - or if you like, the same thing as fiscal stimulus plus QE.
Incidentally, where the monetary base takes the form of gold or some other rare metal, a fall in demand to inadequate levels would cause the price of gold to rise relative to other other goods, which in turn would induce gold miners to produce more of the stuff. Thus in that scenario, the free market’s response to inadequate demand is to increase the total value of the monetary base BOTH via increasing the number of units (ounces of gold or whatever) and via increasing the value of each unit.
The above argument is very near to saying that inadequate demand should be tackled by fiscal stimulus funded by new money, which would be a bit of a change from current arrangements. But don’t worry about that. The best way implement that “fiscal stimulus funded by new money” was set out in the submission to the UK’s Vickers Commission authored by Positive Money, the New Economics Foundation and Prof Richard Werner.
The DIFFERENCE BETWEEN “fiscal stimulus funded by new money” and simply increasing the value of the monetary base (a la free market) is that in the latter case no stimulatory effect comes from extra spending INITIALLY: that is, the extra spending is a SECONDARY effect of increasing the total value of the stock of money. Still, there isn't a huge difference between those two ways of increasing demand, and they both make more sense than interest rate adjustments, as indeed is argued in the latter submission.
Plus (14th August 2016), see this "anti monetary policy" letter by several economists in The Guardian: