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Debt, Deleveraging and the Liquidity Trap

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Author Info

  • Paul Krugman

    (Princeton)

  • Gauti B. Eggertsson

    (NY Fed)

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.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1166.

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Date of creation: 2011
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Handle: RePEc:red:sed011:1166

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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  1. James Tobin, 1975. "Keynesian Models of Recession and Depression," Cowles Foundation Discussion Papers 387, Cowles Foundation for Research in Economics, Yale University.
  2. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  3. De Long, James Bradford & Summers, Lawrence H, 1986. "Is Increased Price Flexibility Stabilizing?," American Economic Review, American Economic Association, vol. 76(5), pages 1031-44, December.
  4. Woodford, Michael, 2000. "Monetary Policy in a World without Money," International Finance, Wiley Blackwell, vol. 3(2), pages 229-60, July.
  5. Vasco Curdia & Michael Woodford, 2008. "Credit Frictions and Optimal Monetary Policy," Discussion Papers 0809-02, Columbia University, Department of Economics.
  6. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  7. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
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Cited by:
  1. Peter Skott & Soon Ryoo, 2012. "Public Debt and Functional Finance in an OLG Model with Imperfect Competition," UMASS Amherst Economics Working Papers 2012-10, University of Massachusetts Amherst, Department of Economics.

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