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The Simple Analytics of Debt-Driven Business Cycles

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  • Thomas I. Palley

Abstract

This paper explores the economics of debt-driven business cycles, distinguishing between Keynesian and new Keynesian approaches. Keynesians emphasize the impact of borrowing and debt on aggregate demand (AD), whereas new Keynesians emphasize the impact on aggregate supply (AS). A unique Keynesian feature is emphasis on debtor – creditor debt-service income transfers. Business cycles result from two mechanisms. One is the multiplier – accelerator AD mechanism. The second is a predator – prey mechanism whereby increased income feeds the level of debt, but the level of debt preys on the level of income. Both the Keynesian and new Keynesian approaches are logically coherent, but the latter is at odds with the stylized facts of business cycles.

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Paper provided by Political Economy Research Institute, University of Massachusetts at Amherst in its series Working Papers with number wp200.

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Date of creation: 2009
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Handle: RePEc:uma:periwp:wp200

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Keywords: debt; debt service burdens; business cycle; multiplier – accelerator; predator – prey model;

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  1. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February.
  2. Caskey, John & Fazzari, Steven M, 1987. "Aggregate Demand Contractions with Nominal Debt Commitments: Is Wage Flexibility Stabilizing?," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 583-97, October.
  3. Marc Jarsulic, 1989. "Endogenous Credit and Endogenous Business Cycles," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 12(1), pages 35-48, October.
  4. Palley, Thomas I., 1999. "General disequilibrium analysis with inside debt," Journal of Macroeconomics, Elsevier, vol. 21(4), pages 785-803.
  5. Amitava Krishna Dutt, 2006. "Maturity, Stagnation And Consumer Debt: A Steindlian Approach," Metroeconomica, Wiley Blackwell, vol. 57(3), pages 339-364, 07.
  6. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  7. Palley, Thomas I, 1997. "Expected Aggregate Demand, the Production Period and the Keynesian Theory of Aggregate Supply," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(3), pages 295-309, June.
  8. Peter Skott, 2008. "Theoretical and empirical shortcomings of the Kaleckian investment function," UMASS Amherst Economics Working Papers 2008-11, University of Massachusetts Amherst, Department of Economics, revised Dec 2009.
  9. Palley, Thomas I, 1996. "Inside Debt, Aggregate Demand, and the Cambridge Theory of Distribution," Cambridge Journal of Economics, Oxford University Press, vol. 20(4), pages 465-74, July.
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