Garett Jones  

EconTalk: Russ and I discuss Fisher's Debt-Deflation Theory

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As always, I enjoyed the hour.  Hope you do as well.

I suspect it was this post that led to the invitation.  I really do believe Fisher's 1933 Econometrica article offers a more complete model of the entire business cycle process than anything in Keynes's General Theory

It took Hicks, Alvin Hansen, and other interpreters to translate the General Theory into a complete model, one where you could intuitively understand who was making which decisions, how it all added up to a complete economy where everyone was being at least modestly rational.  

Fisher, by contrast, implicitly tells you: "Just take your old, familiar classical model, perfectly flexible wages and prices, but add in just this one thing: Debt contracts that are tough to get out of."  Then he shows the the consequences of that one tweak.  They are not small.  

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CATEGORIES: Finance , Macroeconomics , Money



COMMENTS (3 to date)
david writes:

Didn't it take until the 1990s for it to be rigorously shown, and widely accepted, that near-rational behavior in monopolistically-competitive price-setting could actually result in recessions of large magnitudes?

Note that Fisher is not advocating a debt-deflationary theory of a New Keynesian "debt is nominally rigid" stripe. It doesn't function via nominal rigidity plus monopolistic competition plus near-rational behavior, which you seem to value.

Fisher is advocating a pre-dichotomy theory where the interaction is instead between nominal rigidity and 'pessimism' and fire-sales of assets. Note, e.g., that Fisher is asserting that debt-deflation alone generates more deflation: inflation is not here everywhere a purely monetary phenomenon. This is not purely classical.

And it is also not rigorous: without price-setting power, a fire-sale of assets should just be a wealth transfer from unfortunate debtors to creditors. One can rationally describe why debtors are then pessimistic, but not creditors, without invoking a decidedly non-classical animal-spirits variable. Fisher calls it "distrust".

Jason writes:

How would a debt deflation theory explain unemployment?

david writes:

@Jason

No involuntary unemployment in debt-deflation models; any spike in observed unemployment is caused by falling labour force participation rates plus an imperfect definition of 'unemployment' not quite identical to its economic involuntary sense (i.e., people still say they are seeking jobs, but won't actually accept them at the now-lower market rate).

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