Wednesday, March 25, 2009

How do you spell debt-deflation?

I've now accepted the basic framework that Richard Koo and Martin Wolf have expounded, namely that we are in for a balance sheet recession a la Japan -- the economy can't grow if we all try to save up and pay off our debt at the same time. The only question is how this works when big chunk of the debt is not in the hands of a corporation which can be declared insolvent, but of a consumer who cannot. In Japan, and as you can see here, during the Great Depression, the debt was mainly corporate. Corporations can't remain underwater for long, given that their creditors and equity owners tend to rapidly pull the plug on them. So they have a strong impetus to pay down debt as fast as possible. Nobody forces you to sell your house as soon as you get upside-down on the mortgage. As long as you don't lose your job (or wise up and send some jingle mail) you just keep working it off like an old-time sharecropper. This might make you spend less, but it probably doesn't lead you to literally pay down your mortgage more rapidly. I'm still unclear if the macro-economic consequences of this are different.

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