Indebted Demand

71 Pages Posted: 15 Apr 2020

See all articles by Atif R. Mian

Atif R. Mian

Princeton University - Department of Economics; Princeton University - Woodrow Wilson School of Public and International Affairs; NBER

Ludwig Straub

Harvard University

Amir Sufi

University of Chicago - Booth School of Business; NBER

Date Written: 2020

Abstract

We propose a theory of indebted demand, capturing the idea that large debt burdens by households and governments lower aggregate demand, and thus natural interest rates. At the core of the theory is the simple yet under-appreciated observation that borrowers and savers differ in their marginal propensities to save out of permanent income. Embedding this insight in a two-agent overlapping-generations model, we find that recent trends in income inequality and financial liberalization lead to indebted household demand, pushing down natural interest rates. Moreover, popular expansionary policies—such as accommodative monetary policy and deficit spending—generate a debt-financed short-run boom at the expense of indebted demand in the future. When demand is sufficiently indebted, the economy gets stuck in a debt-driven liquidity trap, or debt trap. Escaping a debt trap requires consideration of less standard macroeconomic policies, such as those focused on redistribution or those reducing the structural sources of high inequality.

Keywords: aggregate demand, debt, interest rates, inequality, secular stagnation

JEL Classification: E210, E320, E430, E440, E520, E620, G510, D310

Suggested Citation

Mian, Atif R. and Straub, Ludwig and Sufi, Amir, Indebted Demand (2020). CESifo Working Paper No. 8210, Available at SSRN: https://ssrn.com/abstract=3576287

Atif R. Mian (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

Princeton University
Princeton, NJ 08544-1021
United States

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ludwig Straub

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

Amir Sufi

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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