The Economic Legacy of Hyman Minsky, Volume II
Edited by Riccardo Bellofiore and Piero Ferri
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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