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Aggregate Demand Contractions with Nominal Debt Commitments: Is Wage Flexibility Stabilizing?

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  • Caskey, John
  • Fazzari, Steven M

Abstract

When nominal debt payments commitments exist, output losses following an aggregate demand contraction will be larger and more persistent. Paradoxically, output can be less stable if wages are more flexible. This occurs because falling wages and prices cause debtors' cash flow to deteriorate relative to their debt commitments. To reduce the chance of incurring bankruptcy costs, debtors cut expenditure. Creditor's wealth increases from an unexpected deflation but their gain does not offset debtors' loss because of the increased threat of bankruptcy and associated costs. Net wealth and aggregate demand fall, magnifying the effect of the initial contraction. Copyright 1987 by Oxford University Press.

Suggested Citation

  • Caskey, John & Fazzari, Steven M, 1987. "Aggregate Demand Contractions with Nominal Debt Commitments: Is Wage Flexibility Stabilizing?," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 583-597, October.
    • Handle: RePEc:oup:ecinqu:v:25:y:1987:i:4:p:583-97
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    Cited by:

    1. Leland B. Yeager & Robert L. Greenfield, 1989. "Can Monetary Disequilibrium Be Eliminated?," Cato Journal, Cato Journal, Cato Institute, vol. 9(2), pages 405-428, Fall.
    2. Lawrence H. Summers & Hyman P. Minsky & Paul A. Samuelson & William Poole & Paul A. Volcker, 1991. "Macroeconomic Consequences of Financial Crises," NBER Chapters, in: The Risk of Economic Crisis, pages 135-182, National Bureau of Economic Research, Inc.
    3. Thomas I. Palley, 2013. "Horizontalists, verticalists, and structuralists: the theory of endogenous money reassessed," Review of Keynesian Economics, Edward Elgar Publishing, vol. 1(4), pages 406—424-4, OCT.
    4. Thomas I. Palley, 2008. "Keynesian Models of Deflation and Depression Revisited: Inside Debt and Price Flexibility," Working Papers wp169, Political Economy Research Institute, University of Massachusetts at Amherst.
    5. Thomas I. Palley, 2013. "The Simple Analytics of Debt-driven Business Cycles," Palgrave Macmillan Books, in: Financialization, chapter 4, pages 62-81, Palgrave Macmillan.
    6. Thomas I. Palley, 2013. "Financialization: What It Is and Why It Matters," Palgrave Macmillan Books, in: Financialization, chapter 2, pages 17-40, Palgrave Macmillan.
    7. Palley, Thomas I., 2008. "Keynesian models of deflation and depression revisited," Journal of Economic Behavior & Organization, Elsevier, vol. 68(1), pages 167-177, October.
    8. Thomas I. Palley, 2010. "Inside Debt and Economic Growth: A Neo-Kaleckian Analysis," Chapters, in: Mark Setterfield (ed.), Handbook of Alternative Theories of Economic Growth, chapter 14, Edward Elgar Publishing.
    9. Greenwood-Nimmo, Matthew & Tarassow, Artur, 2016. "Monetary shocks, macroprudential shocks and financial stability," Economic Modelling, Elsevier, vol. 56(C), pages 11-24.
    10. Victor Zarnowitz, 1989. "Cost and Price Movements in Business Cycle Theories and Experience: Causes and Effects of OBserved Changes (SEE ALSO WP3131-Send out together)," NBER Working Papers 3132, National Bureau of Economic Research, Inc.
    11. Steven M. Fazzari, "undated". "The Investment-Finance Link, Investment and U.S. Fiscal Policy in the 1990s," Economics Public Policy Brief Archive 9, Levy Economics Institute.
    12. Thomas Palley, 1997. "Endogenous money and the business cycle," Journal of Economics, Springer, vol. 65(2), pages 133-149, June.
    13. Thomas I. Palley, 2009. "Inside Debt and Economic Growth: A Cambridge - Kaleckian Analysis," IMK Working Paper 02-2009, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    14. T.I. Palley, 1997. "European Monetary Union: an old Keynesian guide to issues," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 50(201), pages 147-164.

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