Debt deflation

About: Debt deflation is a research topic. Over the lifetime, 418 publications have been published within this topic receiving 15068 citations.

Stabilizing an Unstable Economy

Abstract: "Mr. Minsky long argued markets were crisis prone. His 'moment' has arrived." -The Wall Street Journal In his seminal work, Minsky presents his groundbreaking financial theory of investment, one that is startlingly relevant today. He explains why the American economy has experienced periods of debilitating inflation, rising unemployment, and marked slowdowns-and why the economy is now undergoing a credit crisis that he foresaw. Stabilizing an Unstable Economy covers: The natural inclination of complex, capitalist economies toward instability Booms and busts as unavoidable results of high-risk lending practices "Speculative finance" and its effect on investment and asset prices Government's role in bolstering consumption during times of high unemployment The need to increase Federal Reserve oversight of banks Henry Kaufman, president, Henry Kaufman & Company, Inc., places Minsky's prescient ideas in the context of today's financial markets and institutions in a fascinating new preface. Two of Minsky's colleagues, Dimitri B. Papadimitriou, Ph.D. and president, The Levy Economics Institute of Bard College, and L. Randall Wray, Ph.D. and a senior scholar at the Institute, also weigh in on Minsky's present relevance in today's economic scene in a new introduction. A surge of interest in and respect for Hyman Minsky's ideas pervades Wall Street, as top economic thinkers and financial writers have started using the phrase "Minsky moment" to describe America's turbulent economy. There has never been a more appropriate time to read this classic of economic theory.

House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle

Abstract: I develop a general equilibrium model with sticky prices, credit constraints, nominal loans and asset prices. Changes in asset prices modify agents’ borrowing capacity through collateral value; changes in nominal prices affect real repayments through debt deflation. Monetary policy shocks move asset and nominal prices in the same direction, and are amplified and propagated over time. The “financial accelerator” is not constant across shocks: nominal debt stabilises supply shocks, making the economy less volatile when the central bank controls the interest rate. I discuss the role of equity, debt indexation and household and firm leverage in the propagation mechanism. Finally, I find that monetary policy should not target asset prices as a means of reducing output and inflation volatility.

Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach*

Abstract: In this paper we present a simple New Keynesian-style model of debt-driven slumps – that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption: Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift, a Keynesiantype multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself.

Self-Fulfilling Debt Crises

Abstract: We characterize the values of government debt and the debt's maturity structure under which financial crises brought on by a loss of confidence in the government can arise within a dynamic, stochastic general equilibrium model. We also characterize the optimal policy response of the government to the threat of such a crisis. We show that when the country's fundamentals place it inside the crisis zone, the government may be motivated to reduce its debt and exit the crisis zone because this leads to an economic boom and a reduction in the interest rate on the government's debt. We show that this reduction can be gradual if debt is high or the probability of a crisis is low. We also show that, while lengthening the maturity of the debt can shrink the crisis zone, credibility-inducing policies can have perverse effects. Financial crises brought on by a loss of confidence in the government can arise suddenly and threaten countries with huge losses. We analyse the conditions that make these crises possible and what policy makers should do in the face of this kind of risk. To address these issues, we examine optimal government policy in a dynamic, stochastic general equilibrium model in which self-fulfilling crises can arise. Because of the government's need to roll over its debt, a liquidity crunch induced by the inability to sell new debt can lead to a self-fulfilling default. We show that, if fundamentals like the level of the government's debt, its maturity structure, and the private capital stock, lie within a particular range (the crisis zone), then the probability of default is determined by the beliefs of market participants. We show that a government is motivated to reduce its debt and exit the crisis zone because doing so leads to an economic boom and a reduction in the interest rate on the government's debt. The distinguishing feature of this paper is that it examines optimal policy within an environment in which not only can crises occur in the first period, but crises can occur in subsequent periods with positive probability. This is important since we show that previously proposed policies that seek to avert a crisis by reacting contemporaneously, such as pegging the interest rate on the government debt or lengthening the maturity of the debt being sold once a crisis has started, are ineffectual in our model. Instead, it is only preemptive policies, which seek to remove the conditions that make future crises possible, that can be effective. To examine optimal debt policy, we construct a time-consistent equilibrium of our model with a (relatively) easy-to-characterize Markov structure in which a crisis can occur with a positive probability whenever the level and maturity structure of the government's debt and the capital stock are in the crisis zone. We show that within the crisis zone, the