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Friday, September 26, 2003

Irving Fisher on Debt Deflation

Deflation and the value of the dollar are two of the topics on the US economy agenda, so I am grateful to Lloyd at Macro Mouse for sending me two links. One an interview with Richard Duncan on the dollar, the other a student essay which really does present an extremely well-argued presentation of Irving Fisher's theory of Debt Deflation.

Irving Fisher developed The Debt-Deflation Theory in 1933 in order to explain the economic mechanism that can lead to a Great Depression such as the one experienced by the US economy from 1929 to 1933. The main point of the theory is that over indebtedness acts in conjunction with deflation to produce a contracting economy causing bankruptcies, rising unemployment and falling profits. Over the last 20 years, one of the US economic policy makers’ goals has been to lower the rate of inflation. However a recent downward trend in the already low inflation, together with an impressive growth in debt, has brought to light Fisher’s theory and triggered fears of a debt-deflation induced depression.

The Debt-Deflation Theory of Great Depressions is an explanation by Fisher of the apparent boom bust pattern prevailing in the economy. He divides the theory into four sections. In the first section, “Cycle Theory in general”, Fisher defines different types of economic cycles and their possible causes. In the second section, “The Roles of Debt and Deflation”, he provides a theory of how excess debt and the consequent deflation play a major role in the boom bust cycle. The third section provides an overview of the Great Depression in light of his new theory and introduces the concept of inflation as a cure to depression and deflation. The last section explores the possible “Debt Starters” that initially triggers a boom economy.

In the first section on cycle theory, Fisher dismisses the idea of the business cycle being a single, simple, self-generating cycle as a myth. In its place he introduces the notion that there are many interacting cycles within the economy also interacting with non-cyclical forces such as growth and haphazard tendencies. He divides cyclical tendencies into two types, forced cycles and free cycles. Forced cycles are imposed onto the economy by outside forces, such as the yearly season cycle, day-night cycle, and monthly and weekly cycles imposed by religion and custom. The free cycle is self-generating and is commonly thought of when referring to the business cycle.

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