ECO 368M - Fisher

four phases in the psych of borrowing that led to over-indebtedness (think ICFS: ice cold scams flourish)

1. income: future expected higher income

2. capital gain: the hope of selling assets soon for capital gain

3. speculation: widespread optimism creates opportunities for reckless speculation

4. fraud: boom can end in outright fraud

two ways falling prices intensified debt during Great Depression

1. reduced borrowers’ wealth and the value of their collateral, leading to distress sales, defaults, and bank losses

2. deflation in general price level increased the real burden of debt that remained unpaid, making repayment more difficult

two steps in Fisher’s debt-deflation cycle, beginning with attempts to repay debt

1. heavily indebted borrowers sell assets to repay loans, making prices fall further

2. falling general price level raises the real burden of nominal debt, distress sales and defaults deepen the downturn

two ways debt and weak bank balance sheets contributed to Japan’s prolonged stagnation

1. after property and equity bubbles burst, indebted firms and households reduced spending to pay loans

2. bad loans and weak balance sheets restricted lending, making it harder for businesses/households to spend/invest

two ways expected continued deflation could prolong Japan’s slump

1. households expecting lower prices may postpone purchases, reducing demand

2. firms expecting weak demand may delay investment

expected deflation becomes self-fulfilling

two ways having borrowing and falling asset prices can amplify downturn, specifically in the GFC

1. as house prices fell, indebted borrowers had less collateral and were more likely to default

2. loan losses weakened bank balance sheets and restricted credit, reducing spending and investment

what criticism of Fisher’s theory does Yueh describe? and how does Bernanke’s credit crunch mechanism address it?

criticism: redistribution of wealth from debtors to creditors doesn’t explain a large decline in overall economic activity
Bernanke: argued that defaults, loans, and falling asset values weaken both lenders and borrowers; reduced lending lowers consumption/investment which amplifies the downturn

1) define reflation and 2) explain how fisher expects it to reduce the real burden of debt

1. raising the general price level after deflation

2. Fisher proposed expanding the money supply to restore prices and a higher price level would reduce the real value of debts and make them easier to repay

two responses to Japan’s deflation

1. QE: central bank purchases digital assets to inject money and ease financial conditions

2. cutting interest rates towards 0: lower interest rates aimed to encourage borrowing, spending, and investment during 1990s slump

two similarities between Japan’s lost decades and GFC

1. both followed rapid increases in property-related asset prices and borrowing

2. both raised concerns about deflation after asset bubbles burst and falling general prices could increase real debt burdens, making recovery harder

difference in policy responses to Japan’s slump and the GFC and why it mattered

Japan: repeated monetary easing, including QE, but struggled to reverse deflation for years

GFC: central banks cut interest rates close to 0 and used asset purchases to guard against deflation

it mattered because it was an attempt to avoid Japan’s prolonged trap without establishing monetary policy alone ensured recovery

two reasons stronger financial regulation might reduce risk of debt-deflation, according to Fisher’s theory

1. regulation can curb risky lending and unsustainable buildups of debt before a bubble bursts

2. supervision can limit fragile financial practices and strengthen institutions, reducing the risk that defaults and asset sales trigger a wider credit contraction

1) define moral hazard and 2) one way regulation could reduce it when banks expect rescue

1. when a bank takes greater risks because it expects a rescue if it fails

2. regulation that restrains risky lending or requires stronger bank capital can reduce that incentive

one idea from Minsky that helps account for the buildup of the GFC

argued that prolonged prosperity can encourage speculative borrowing and increase fragile finance, helping explain the buildup of mortage debt before 2008

one idea from Fisher that explains the dangers after a debt bubble bursts

explained how attempts to repay debts can cause distress sales, falling prices, and further financial distress

two policy lessons from Japan’s experience with deflation/stagnation

1. avoid sustained deflation: falling prices raise the real burden of nominal debts and can depress spending

2. consider more than QE alone: monetary easing may not be enough to change expectations or restore demand, use both monetary and fiscal measures

two reasons why QE alone struggled to end deflation in Japan

1. entrenched expectations: expectations of falling prices encouraged households and firms to hold back on spending, making deflation self-fulfilling

2. structural and financial obstacles: aging population and the need for structural changes hindered recovery