Credit Booms, Debt Overhang and Secular Stagnation

45 Pages Posted: 27 Dec 2016 Last revised: 4 Dec 2017

See all articles by Gerhard Illing

Gerhard Illing

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Yoshiyasu Ono

Osaka University - Institute of Social and Economic Research (ISER)

Matthias Schlegl

Ludwig Maximilian University of Munich, Faculty of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: November 28, 2017

Abstract

Why do advanced economies fall into prolonged periods of economic stagnation, particularly in the aftermath of credit booms? We present a model of persistent aggregate demand shortage based on strong liquidity preferences of households, in which we incorporate financial imperfections to study the interactions between debt, liquidity and asset prices. We show that financially more deregulated economies are more likely to experience persistent stagnation. In the short run, credit booms can mask this structural aggregate demand deficiency. However, the resulting debt overhang permanently depresses spending in the long run since deleveraging becomes self-defeating because of debt deflation. These findings are in line with the macroeconomic developments in Japan during its lost decades and other advanced economies before and during the Great Recession.

Keywords: Secular Stagnation, Aggregate Demand Deficiency, Liquidity Preferences, Financial Frictions, Leverage

JEL Classification: E13, E21, E32, E41, E51

Suggested Citation

Illing, Gerhard and Ono, Yoshiyasu and Schlegl, Matthias, Credit Booms, Debt Overhang and Secular Stagnation (November 28, 2017). ISER Discussion Paper No. 988. Available at SSRN: https://ssrn.com/abstract=2887827 or http://dx.doi.org/10.2139/ssrn.2887827

Gerhard Illing

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany

HOME PAGE: http://www.sfm.vwl.uni-muenchen.de/

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Yoshiyasu Ono (Contact Author)

Osaka University - Institute of Social and Economic Research (ISER) ( email )

6-1 Mihogaoka
Ibaraki, Osaka 567-0047
Japan

Matthias Schlegl

Ludwig Maximilian University of Munich, Faculty of Economics ( email )

Germany

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