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Debt, Deleveraging and the Liquidity Trap

Listed author(s):
  • Paul Krugman

    (Princeton)

  • Gauti B. Eggertsson

    (NY Fed)

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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File URL: https://economicdynamics.org/meetpapers/2011/paper_1166.pdf
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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1166.

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Date of creation: 2011
Handle: RePEc:red:sed011:1166
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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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. J. Bradford De Long & Lawrence H. Summers, 1985. "Is Increased Price Flexibility Stabilizing?," NBER Working Papers 1686, National Bureau of Economic Research, Inc.
  3. John Moore & Nobuhiro Kiyotaki, "undated". "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  4. Galí, Jordi & López-Salido, J David & Vallés Liberal, Javier, 2005. "Understanding the Effects of Government Spending on Consumption," CEPR Discussion Papers 5212, C.E.P.R. Discussion Papers.
  5. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 459-472, November.
  6. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78-121.
  7. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
  8. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2000. "Currency Crises and Monetary Policy in an Economy with Credit Constraints," CEPR Discussion Papers 2529, C.E.P.R. Discussion Papers.
  9. Woodford, Michael, 2000. "Monetary Policy in a World without Money," International Finance, Wiley Blackwell, vol. 3(2), pages 229-260, July.
  10. Michael Woodford, 2011. "Simple Analytics of the Government Expenditure Multiplier," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(1), pages 1-35, January.
  11. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  12. 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.
  13. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
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