Svensson on Fisher and “Debt Deflation”
The Riksbank’s loss is the blogosphere’s gain. If you are not following along already, Lars Svensson has a great post on Fisher and debt deflation, following an earlier VoxEU post on the effect of monetary policy on debt and income. I can’t read Swedish but Google Chrome can. Here is the translation provided:
A dangerous thing when it comes to debt is what Irving Fisher (1933) called “debt deflation”. It is usually described as deflation causes the real value of nominal debts are growing.Leverage and debt ratio also increases as the nominal debt is fixed while the nominal value of the assets and nominal disposable income falls. This could damage the economy in that it can lead to bankruptcy, “deleveraging” (savings to reduce debt) and “fire sales” (quick sale) of assets with consequent fall in prices.
But central to the idea of “debt deflation” is not in and of itself that it becomes deflation, i.e. negative inflation. What is important is that the price level will be lower than expected. This means that the real debt, leverage and debt ratios are higher than expected and planned. All probably have not realized that this is something that the Riksbank has caused by overriding objective of price stability and for a long time to pursue a policy that provides an inflation well below target. The Riksbank has therefore caused real household debt, leverage and debt ratios become much higher than the inflation rate remained on target.
This is great stuff. But one problem which the UK data illustrates perfectly is that the price level can tell us the “wrong” story about real debt burdens, whereas nominal GDP (or nominal wages) lights the way perfectly.