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Debt-Deflation: Concepts, and a Stylised Model

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  • Goetz von Peter

    (Bank for International Settlements)

Abstract

This 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.

Suggested Citation

  • Goetz von Peter, 2005. "Debt-Deflation: Concepts, and a Stylised Model," Macroeconomics 0505001, University Library of Munich, Germany.
  • Handle: RePEc:wpa:wuwpma:0505001
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    References listed on IDEAS

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    Cited by:

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    2. Deryugina, Elena & Ponomarenko, Alexey & Rozhkova, Anna, 2020. "When are credit gap estimates reliable?," Economic Analysis and Policy, Elsevier, vol. 67(C), pages 221-238.

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    More about this item

    Keywords

    Debt-Deflation; Leverage; Refinancing; Losses; Financial Distress; Distress Selling; Asset Prices; Credit; Inside Money.;
    All these keywords.

    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

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