Analysis by Keith Rankin.
Back in the day, Economics 101 students learned that trying to recover from a depressed economy using monetary policy alone was like ‘pushing on a string’.
Easy monetary policy is supposed to work by getting people – households, businesses, and governments – to incur more debt; in a phrase, to borrow and spend. Easy money alone sometimes works; for example, in an ordinary downturn of the trade cycle. It does not work in a depression or a structural recession (see my Chart Analysis – Structural Recession, Evening Report 21 September 2025); because – for most parties – the overwhelming priority is to get out of debt rather than to recover through debt. The carrot of cheap loans does not appeal to overextended and technically insolvent borrowers.
Recovery through easy monetary policy depends on there being enough potential borrowers willing and able to respond to the monetary carrot.
The central government is such a potential borrower. When the government responds to the incentive, the policy is called easy fiscal policy. It’s a game-changer. Easy monetary policy may mean there’s plenty of money sitting in banks’ balance sheets; sitting waiting to be borrowed and spent. For the economy to recover, that money has to move; money – to be money – must circulate. It requires a spending agent able to take on the risk of more debt in a recession to get money moving once again. The government is generally best-placed to be such an agent, though not necessarily the only one; larger domestic corporates should also be motivated to help with the recovery of the economy which represents their home base.
In a structurally recessed economy, the banks need to create the extra money and the spending agents with deepest pockets need to borrow and spend. It’s not rocket science. Banks will almost always create the money when good customers come to borrow; that’s a central feature of profitable banking.
Will governments which borrow more end up with more debt; with too much debt? The answer is, generally no. By spending, governments generate income and therefore income tax. There’s a multiplier that is particularly powerful during a structural recession. (In 1937, the New Zealand economy had double-digit annual growth, as state-housing funded by new money created the necessary stimulus to get New Zealand out of the Depression.) Customers of governments generate income and therefore income tax. And customers of those customers also generate income and therefore income tax. And so on.
It’s widely known that income tax grows faster than income in an expanding economy, especially a growing economy with two-to-three percent inflation. (And it’s known that income tax shrinks faster than incomes in a contracting and/or deflating economy.) That’s why the Australian government has a Budget surplus (0.6% of GDP) at present and New Zealand has a deficit (-3.1% of GDP); as well as why Australia has less government debt as a percent of GDP (data from Trading Economics; though data users should be critical, that source gives the latest United States quarterly economic growth data at four times what it really is – note the presence or absence of the word ‘annualized’). Australia has a Treasurer who’s not afraid to spend (and despite Australia having higher interest rates, tighter monetary policy); hence the healthy revenue of the Australian Treasury.
In a depressed economy, fiscal policy is the answer. Monetary policy helps of course. But relying on monetary policy alone is like pushing a string. The economy just goes slack. This is not a revelation. It’s basic Economic Principles, as it was once taught.
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Keith Rankin (keith at rankin dot nz), trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.
