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"Debt - deflation" theory refers to the over-indebtedness of economic agents and deflation of these two factors interact to reinforce each other, leading to recession and even cause severe depression.

"Debt - deflation" theory

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"Debt - deflation" theory refers to the over-indebtedness of economic agents and deflation of these two factors interact to reinforce each other, leading to recession and even cause severe depression.

1932 Irving Fisher (lrving Fisher) in the "boom and bust" a book, first proposed the "debt - deflation" theory to explain the Great Depression, that the Great Depression was caused by the excessive debt of the enterprise. After the book was published, his research results were widely recognized. On the basis of this research, in 1933 he published the famous paper "Debt-deflation Theory of the Great Depression", which systematically expounded the logical relationship between excessive debt and deflation. This article has been widely cited since its publication.

Fisher believes that debt and deflation are the two most important variables in the depression. Other relatively minor variables, such as currency in circulation, currency velocity, net asset value, profit, transactions, business confidence, interest rates, can only be significant when combined with one or both of the two variables: excessive debt and deflation. Impact. He made two key assumptions: first, the equilibrium economy was hit by excessive debt; second, there were no other factors that could affect the price level. The starting point of the analysis is that the economy is in an "over-indebtedness" state at a certain point in time, and the debtor or creditor out of prudence often triggers the settlement of debt. This produces the following nine-step chain reaction:

(1) Debt settlement leads to the cheap sale of assets, and (2) The contraction of the deposit currency (because of bank loan repayments), and the decrease in the speed of currency circulation. The contraction of the deposit currency and the decrease in the velocity of currency circulation, when the assets are sold at a low price, cause (3) the price level to fall, that is, the purchasing power of the currency to rise. Because there is no exogenous "reinflation" external intervention, there must be (4) a greater decline in the net asset value of the enterprise, which has accelerated the bankruptcy of the enterprise and (5) the decline in profits. This in turn leads to (6) reductions in output, trading, and wage labor. The loss, bankruptcy and unemployment of the enterprise caused (7) pessimism and loss of confidence, which in turn led to (8) the accumulation of money and the speed of deposit currency circulation. Among the above eight changes, (9) interest rates will also have complex changes, that is, nominal interest rates will fall and real interest rates will rise.

In the actual deflation process, the sequence of these 9 steps is different from the above-mentioned logical sequence. There are adverse reactions between variables, and some processes may repeat. In Appendix 1 of the book "Boom and Depression", Fisher gives a list of the chronological changes in the above variables during the depression. Fisher particularly emphasized that in the logical sequence of debt deflation, except for the initial conditionsexcessive debtand the final resultchanges in interest ratesall other variables change from the price level. decline. If excessive debt does not cause the price level to fall, that is, the downward trend in prices is hampered by inflationary forces, the final cyclical fluctuations will be much milder. Similarly, if deflation is caused by non-debt factors, the consequences will be much smaller. Only when debt and deflation are combined can the greatest catastrophe occur.

Excessive debt and deflation interact. On the one hand, excessive debt causes deflation, and on the other hand, debt-induced deflation will have an adverse effect on debt. Under deflation, the value of outstanding debt is even higher. If the initial debt scale is large enough, the price caused by debt settlement will drop much faster than the reduced nominal debt. Although some nominal debt is cleared, the true size of the outstanding debt will increase due to the decline in price. In this way, individual efforts to reduce their debt burden have increased the pressure on debt. This leads to a paradox that "the more debtors have, the more they owe." This is the root cause of the Great Depression. Fisher calculated the debt of changes in American society during the Great Depression, to further verify his theory. According to calculations, to March 1933, due to the decline in prices, real liabilities of society as a whole increased by about 40% over the beginning of 1929.

Although Fisher's "debt - deflation" theory provides a reasonable explanation for the Great Depression, but because of Roosevelt's New Deal and rebellious people to classical theory, the popular view of Keynes open to the idea of Fisher It is improperly ignored (Gertler, 1988). So when Wolfson (M.H.Wolfson) and Minsky (H.P.Minsky), who re-discussed and discussion on these ideas inch Fisher, people realized its profundity. These economists discussed by Fisher these ideas further developed its theory.

Wolfson (1996), can be discussed Fisher reason perish on three aspects.

(1) an absolute decline in the price level if necessary. In the contemporary history of the world, a wide range of absolute price levels decline, after all, only appeared once. For this problem, many people have reached a consensus, does not necessarily require an absolute decline in the price level, as long as the inflation rate has dropped, or the actual rate of inflation is less than expected inflation, will also increase the burden on debtors, because they had to borrow the high inflation rate into consideration. For example, Fazzari and Casky (1989) believe that "the key to the (debt-deflation mechanism) lies in the decline in prices or inflation relative to expected levels". Tobin (1980) also said: "These considerations (referred to as" debt - deflation "- the author note) applies not only to the history of ancient Li, the expected high inflation will continue to those who borrowed a lot of debt in the 1970s under the premise If prices actually stabilized once found, one can imagine that they will encounter much trouble! "

What role (2) in the banking system from "debt-deflation" mechanism. Fisher also mentioned that although the banking crisis, but he just as the banking problems - a result of "debt deflation" mechanism, there is no in-depth analysis. On this issue there are also a lot of people did research. Keynes' persuasion Collection "(1932) is considered in play banks in the debt crisis a role in fueling that further credit tightening in liquidity already tight, but there are so many excellent benefits on the cash flow problems of enterprises embarked on a shrinking business, even bankruptcy auction of assets of the road, Tobin (1982) also expressed similar meaning.

(3)? "Debt - deflation" process is how to trigger Fisher just said over-indebtedness can lead to compulsive debt repayment, but not very compelling reason to explain how excessive debt is created, Minsky (Minsky, 1982) once said, "Fisher is not able to identify the 'affordable debt' into those systemic factors 'excessive indebtedness' in." the problem is much more complex than the previous two, so far no satisfactory explanation . Yes - "debt deflation" mechanism for two reasons Minsky (1982) proposed that triggers: rising interest rates (short-term interest rates rise the recent cash outflow increased, affecting the flow of the debtor; long-term interest rates rise in long-term debt and equity prices decline, the debtor's net worth decline, shrinking collateral). decline in asset prices. But Minsky's explanation is too simple and did not clear the problem. On the current development of the theory seems, in order to look for from a purely financial reasons is probably difficult, but added the actual business cycle in this area to use their brains might be more rewarding, as Mervyn King (Mervyn King, 1994) as from terms of consumption, distribution of wealth, such as precautionary savings to construct theoretical models about "debt-deflation" mechanism.

1 with Liu Yongming. Deflation theory. Shanghai University of Finance and Economics Press, 2002 July 1st edition.

2 prevent deflation and keep the economy growing faster research. Peking University Press, October 2005, 1st edition.

3 Xiao Songhua. Contemporary Monetary Theory and Policy. Southwestern University of Finance and Economics Press, First Edition, June 2001. ^[1]