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Financial Fragility and Investment in the Capitalist Economy

The Economic Legacy of Hyman Minsky, Volume II

Edited by Riccardo Bellofiore and Piero Ferri

Hyman Minsky is renowned for his theoretical and empirical investigation of the capitalist economy. In this book, a distinguished group of contributors provides an authoritative account of his contribution to the analysis of capitalism and, more particularly, to the fields of monetary and post Keynesian economics.
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Chapter 7: The macrodynamics of debt deflation

Carl Chiarella, Peter Flaschel and Willi Semmler


7. The macrodynamics of debt deflation Carl Chiarella, Peter Flaschel* and Willi Semmler 1 INTRODUCTION In the recent public debate on problems of the world economy, ‘deflation’ or more specifically ‘debt deflation’ has again become an important topic. The possible role of debt deflation in triggering the Great Depression of the 1930s has come back into academic studies as well as into the writings of economic and financial journalists. It has been observed that there are similarities between recent global trends and the 1930s, namely the joint occurrence of high levels of debt and falling prices: the dangerous downside to cheaper cars and TVs when debt is high. Debt deflation thus concerns the interaction of high nominal debt of firms, households and countries and shrinking economic activity due to falling output prices and increasing real debt. There is often another mechanism accompanying the first one. The other way in which large debt may exert its impact on macroeconomic activity is through the asset market. Asset price inflation during economic expansions normally gives rise to generous credit extension and lending booms. Assets with inflated prices serve as collateral for borrowing by firms, households or countries. On the other hand, when asset prices fall, borrowing capacity of economic agents shrinks, financial failures may set in, macroeconomic activity decreases and consequently large output losses may occur. Countries that have gone through such booms and busts are the Asian countries, in particular Japan, and Russia and...

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