Debt deflation

Debt deflation is a picture that recessions together with depressions are due to a overall level of debt rising in real advantage because of deflation, causing people to default on their consumer loans and mortgages. Bank assets fall because of a defaults and because the service of their collateral falls, leading to a surge in bank insolvencies, a reduction in lending and by extension, a reduction in spending.

The opinion was developed by Irving Fisher coming after or as a solution of. the Wall Street Crash of 1929 and the ensuing Great Depression. The debt deflation theory was familiar to John Maynard Keynes prior to Fisher's discussion of it, but he found it lacking in comparison to what would become his theory of liquidity preference. The theory, however, has enjoyed a resurgence of interest since the 1980s, both in mainstream economics and in the heterodox school of post-Keynesian economics, and has subsequently been developed by such post-Keynesian economists as Hyman Minsky and by the neo-classical mainstream economist Ben Bernanke.

Fisher's formulation 1933

In Fisher's formulation of debt deflation, when the debt bubble bursts the coming after or as a a thing that is said of. sequence of events occurs:

Assuming, accordingly, that, at some constituent in time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following multinational of consequences in nine links:

Prior to his theory of debt deflation, Fisher had subscribed to the then-prevailing, and still mainstream, theory of general equilibrium. In structure to apply this to financial markets, which involve transactions across time in the defecate of debt – receiving money now in exchange for something in future – he portrayed two further assumptions:

In view of the Depression, he rejected equilibrium, and covered that in fact debts might not be paid, but instead defaulted on:

It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any component of them, will "stay put," in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave.

He further rejected the notion that over-confidence alone, rather than the resulting debt, was a significant element in the Depression:

I fancy that over-confidence seldom does any great damage except when, as, and if, it beguiles its victims into debt.

In the context of this quote and the coding of his theory and the central role it places on debt, it is of note that Fisher was personally ruined due to his having assumed debt due to his over-confidence prior to the crash, by buying stocks on margin.

Other debt deflation theories work not assume that debts must be paid, noting the role that default, bankruptcy, and foreclosure play in contemporary economies.

Initially Fisher's work was largely ignored, in favor of the work of Keynes.

The following decades saw occasional portion of acknowledgment of deflationary spirals due to debt in the mainstream, notably in Eckstein & Sinai 1990, but private debt remained absent from mainstream macroeconomic models.

James Tobin cited Fisher as instrumental in his theory of economic instability.

Debt-deflation theory has been studied since the 1930s but was largely ignored by neoclassical economists, and has only recently begun to gain popular interest, although it maintain somewhat at the fringe in U.S. media.