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International debt deleveraging

This paper provides a framework to understand debt deleveraging in a group of financially integrated countries. During an episode of international deleveraging, world consumption demand is depressed and the world interest rate is low, reflecting a high propensity to save. If exchange rates are allowed to float, deleveraging countries can rely on depreciations to increase production and mitigate the fall in consumption associated with debt reduction. The key insight of the paper is that in a monetary union this channel of adjustment is shut off, because deleveraging countries cannot depreciate against the other countries in the monetary union, and therefore the fall in the demand for consumption and the downward pressure on the interest rate are ampliflied. As a result, deleveraging in a monetary union can generate a liquidity trap and an aggregate recession.

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File URL: https://econ-papers.upf.edu/papers/1401.pdf
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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1401.

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Date of creation: Nov 2012
Date of revision: Sep 2016
Handle: RePEc:upf:upfgen:1401
Contact details of provider: Web page: http://www.econ.upf.edu/

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