By C Driver, E Karakitsos and M Bunyard Fixed investment as a share of GDP has declined over a long period in many G10 countries. The aim of the paper is to provide a theoretical framework for explaining this. The model emphasises the negative effect on investment of uncertainty about the effects of a policy response to an output gap. When government contracts demand to close an output gap that is the result of an initial decline in fixed investment, it tends to exert a cumulative depressive effect on capacity and growth. Since this involves a dynamic process the mechanisms at work are illustrated through a theoretical simulation approach.
Banks meet all creditworthy demand for loans and the central bank supplies the necessary reserves.
However a number of institutional changes have recently taken place in the UK which call this sequence into question. Household demand has taken over from corporate demand as the major component in the aggregate demand for bank credit. If credit is required for all types of transactions, we might therefore expect the demand for loans to depend more directly on total transactions than on those related to output alone. This paper documents those institutional changes and considers some of the implications.