Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach

In this article we present a simple new Keynesian-style model of debt-driven slumps-that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption. Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift and toil, a Keynesian-type multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan's lost decade (now in its 18th year) and the Great Depression itself. (JEL Codes: E32, E52, E62).