Debt-Deflation: Concepts, and a Stylised Model
AbstractThis paper proposes a model of how agents adjust their asset holdings in response to losses in general equilibrium. By emphasising the relation between deflation and financial distress, we capture some original features of the early debt-deflation literature, such as distress selling, instability, and endogenous monetary contraction. The agents affected by a shock sell off assets to prevent their debt from crowding out consumption. But their distress-selling causes a decline in equilibrium prices, and the resulting losses elicit reactions by all agents. This activates several channels of debt-deflation. Yet we show that this process remains stable, even in the presence of large shocks, high indebtedness, and wide-spread default. What keeps the asset market stable is the presence of agents without prior debt or losses, who borrow to exploit the expected asset price recovery. By contrast, debt-deflation becomes unstable when agents try to contain their indebtedness, or when a credit crunch interferes with the accommodation necessary for stability.
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Bibliographic InfoPaper provided by EconWPA in its series Macroeconomics with number 0505001.
Length: 54 pages
Date of creation: 02 May 2005
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Debt-Deflation; Leverage; Refinancing; Losses; Financial Distress; Distress Selling; Asset Prices; Credit; Inside Money.;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-05-07 (All new papers)
- NEP-CBA-2005-05-07 (Central Banking)
- NEP-FIN-2005-05-07 (Finance)
- NEP-MAC-2005-05-07 (Macroeconomics)
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