Debt Deflation - Mainstream Interest

Mainstream Interest

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

The following decades saw occasional mention of deflationary spirals due to debt in the mainstream, notably in The Great Crash, 1929 of John Kenneth Galbraith in 1954, and the credit cycle has occasionally been cited as a leading cause of economic cycles in the post-WWII era, as 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.

The lack of influence of debt-deflation in academic economics is thus described by Ben Bernanke in Bernanke (1995, p. 17):

Fisher's idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.

Bernanke's dismissal of debt deflation is criticized as improperly applying the theory of general equilibrium – in equilibrium, marginal redistribution of income produces no macroeconomic effects, but financial crises are characterized by not being in equilibrium and markets failing to clear – debt ceasing to grow and instead falling, debtors defaulting, rising unemployment – and thus, it is argued, equilibrium analysis is inapplicable and misleading.

There was a renewal of interest in debt deflation in academia in the 1980s and 1990s, and a further renewal of interest in debt deflation due to the financial crisis of 2007–2010 and the ensuing Great Recession.

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 remains somewhat at the fringe in U.S. media. In 2008, one legal journal wrote, "Bernanke has made sure that the second leg of a Fisherian debt deflation will not occur. But, past and present U.S. authorities have failed to adequately restore the balance sheets of over-leveraged banks, firms, and households." In 2011, another law journal wrote, "the global economy has recently experienced a classic Minsky crisis - one with intertwined cyclical and institutional (structural) dimensions."

In 2012, the theory was empirically validated by non-partisan, peer-reviewed economic research conducted by Harvard University economists, funded and published by the National Bureau of Economics. The researchers evaluated the causes of financial collapses both in recent modern times and throughout history. The research also reviewed economic studies dating from 2010 through 2012. The findings indicate that large amounts of private and public combined debt and continuing debt overhangs led to decrease in GDP growth and large-scale financial events. Private debt was often merged into public debt during crises. The research also found that in 50% of economic upheavals, interest rates did not go up but instead remained the same or lower than usual.

This has led to spikes in recent concern over America's combined private and public debt loads. The concern is that, because debt exceeds healthy levels and therefore suppresses GDP growth rates over time, it will become increasingly difficult to improve the debt/GDP ratio. The "lost decades" of GDP growth in Japan and Latin America may provide examples of what happens when debt overhangs are not addressed. Japan's 0% GDP growth rate and rising poverty is particularly disconcerting.