Interest rates and aggregate demand

Nick Rowe

"Say's Law is false in a monetary exchange economy. In a monetary economy that produces only apples and bananas, it is perfectly possible to have an excess supply of both apples and bananas. In a monetary economy that produces only goods this year and goods next year, it is perfectly possible to have an excess supply of both goods this year and goods next year. Because there's an excess demand for money, the medium of exchange. And if that's the problem, a cut in a relative price like (Pa/Pb), or a cut in a relative price like (1+r), is not the cure."

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But if people do not expect a return to full employment in the near future, and fear a continuing recession, the New Keynesian model might fail. A cut in real interest rates might not cure an excess supply of goods. Interest rates are the wrong thing to look at. Interest rates are a relative price that only affect relative demand, not Aggregate Demand for goods this year and goods next year."