Mike Konczal posts a very interesting interview of Amir Sufi (University of Chicago Booth School of Business) in his “Rortybomb” blog. As he notes, Amir Sufi and Atif Mian (University of California at Berkeley) are doing the most interesting and important empirical work on what is going on with this Great Recession, or in other terms this great “balance sheet recession”.
They point, specifically, to the problem of the household balance sheet and how debt-to-income and leverage are linked to sluggish growth and employment. While in the aggregate leverage problems do not appear important, because for a borrower there is somewhere else in the economy a creditor, they consider that the borrowers’ situation is really critical because a massive shock can curtail their ability to borrow, and then they are forced either to default or massively pay back their debt burdens, so that, their wealth also curtailed, they have to cut drastically their consumption level. On the other hand the savers do not massively increase their consumption, despite the interest rate collapses, because of the zero lower bound on interest rates. In order to get the savers consume more, you need the interest rate to get really negative (which normally stimulates consumption), but it can’t get negative because of the zero-lower bound on nominal interest rate.
“The normal way you try to get real interest rates negative is through expected inflation, but the only way you can get expected inflation is if you force the current price level down, which is deflation. But the debt burdens are written in nominal terms. If you push the price level down, you get this vicious cycle where the borrowers cut their consumption even more.” This is the Fisher debt-deflation stuff.
To get out of it the only solution is not fiscal stimulus (pace Paul Krugman) but it is “writing down the debts of borrowers. That’s the number one policy that fixes the problem.”
European governments, and especially the German one, should think that over, I presume.
The whole post is well worth reading, here.