Transcript Eggertsson and Krugman Debt, Deleveraging, and the Liquidity Trap

Eggertsson and Krugman
Debt, Deleveraging, and the Liquidity Trap
All debt is not created equal.
•Borrowers want to spend more now than savers do
•That’s why they’re borrowers/debtors
•A deleveraging shock hits – a Minsky moment
Eggertsson and Krugman
Debt, Deleveraging, and the Liquidity Trap
All debt is not created equal.
•Borrowers want to spend more now than savers do
•That’s why they’re borrowers/debtors
•A deleveraging shock hits – a Minsky moment
•Acceptable level of indebtedness falls
•Debtors must reduce spending…but creditors won’t spend enough
to keep aggregate demand up
•The “natural rate of interest” corresponding to full
employment becomes negative
…but there’s a zero lower bound
•If interest rate could fall enough, savers would spend more
•The economy would expand, debtors would earn more and spend
more too (a familiar IS relation)
…but there’s a zero lower bound
Enter Fisher’s Debt Deflation Depression
• Debtors must deleverage  firesale  price decline
– Negative real interest rate would aid recovery
– For real interest rate to become negative, people must expect
inflation…for price level to recover from its low
• Recall Temin-Wigmore/Eggertsson on New Deal and Reflation
• Drop in prices  increased burden of debt
Now comes Upside-Down Demand
Lower Price  Increased burden  Less spending by debtors
…but with i = 0, savers won’t spend enough
“Backward bending” Aggregate Demand
Price down  Burden of debt up  Spending down
P
AD
AS
Y
Zero Lower Bound Paradoxes
• Paradox of thrift
– Additional saving can’t reduce interest rate below zero
lower bound
– Investment won’t increase when saving increases
– Additional saving – less spending  Output down
– Reduced output  Reduced income  Reduced saving
• So saving doesn’t increase after all
Zero Lower Bound Paradoxes: Paradox of toil
People want to work more  Aggregate Supply shifts out
Price Level Declines  Burden of debt increases
Output declines
P
AD
AS0
AS1
Y
Zero Lower Bound Paradoxes: Paradox of flexibility
Deleveraging Shock Decrease in Aggregate Demand
Reduced Price  Increased burden of debt
Output declines more when price is flexible than when it’s sticky
P
AD0
ASflexible
ASsticky
AD1
Y
Recall Eggertsson’s defense of New Deal / NIRA
Sticky wages and prices are “good”
Policy Implications
• Monetary policy: raise inflationary expectations
– Adopt a higher inflation target … lower real interest rate
… but is this credible? (Time consistency problem)
– Higher price lowers debt burden … thus it helps
• Fiscal policy: more public debt can be solution to
too much private debt
– Ricardian equivalence doesn’t bind at zero lower bound
• Liquidity constrained debtors’ spending depends on current
income, not expectations of future income
» They will spend to the limit
– Keynesian multiplier increases when price increases
• Stimulus is highly effective when AD slopes backwards