Tuesday 15 December 2015

Working Paper: The Relationship Between High Debt Levels and Economic Stagnation, Explained by a Simple Cash Flow Model of the Economy

UPDATE: Download latest, Feb 2016 version here. This version contains the derivation.

My working paper, in which I bring together the ideas from this blog in the past year, has now been finished. It is available here (this link may stop working - probably safest to use the above one):

The Relationship Between High Debt Levels and Economic Stagnation, Explained by a Simple Cash Flow Model of the Economy

Empirical data is presented suggesting that high private and, to a lesser extent, public debt levels place a strong drag upon economic growth. A simple, demand based, cash flow (DBCF) model of the economy is developed, separating out flows by marginal propensity to spend. This approach is both logically sound and empirically consistent with the data. It supports a prognosis for the economy and estimate of future NGDP growth. Importantly, it is a model that is flexible enough to incorporate high debt scenarios, and is able to explain the secular stagnation currently experienced by Western economies and Japan. A simulation is also provided to show the danger to stability of allowing private sector debt to fill lost demand. The conclusion is that the zero lower bound has been reached because there is too much private sector debt for the economy to sustain. Demand is perpetually too low because of structural excess saving. The proposed solution is to rebalance the economy using large, preferably monetised, government deficits.


  1. Good work. Now, how about considering the drag on growth related to: 1. A large share of the private debt has little or no asset value; e.g. the $5,000 vacation or the $4,000 of goods worth $400 in a yard sale; and 2. The shift of spending from new goods and infrastructure to maintenance. The more you build and own, private and public, the more maintenance costs. Perpetuation of a foundation that broadens over time is critical to civilization. There is no end state plan for Humanity, but we don't want to go backwards, become hunter-gatherers.

    1. Sorry Tom, I accidentally deleted your second comment. I have pasted it below:

      3. Why do economists consider repayment of debt as destruction of money rather than renewal of credit-worthiness? I worked as a regional planner for 35 years in the U.S. The localities in my region followed the economic theory, upped their quality of life investments to attract growth, but like most areas, wages have not kept up with housing cost, so treading water.

    2. 1) Investment or consumption are choices we make. I think we under invest and will not get the growth in future that we would if we invested more. But consumption is a perfectly valid reason to spend money.
      2) With economic growth, we should have the resources to maintain more and more. Environmental constraints are larger. My fear is that we don't get enough economic growth because of bad policy making that we are running the economy at under capacity and not investing enough.
      3) money is created as credit and thus destroyed when credit is repaid. But it is also reduction of leverage and increase of stability so is a good thing if not offsetting policy is in place.
      4) Regarding house prices, I think we need to look at the amount of credit created over the past 40 years. This has led to a reduction in interest rates and a huge rise in asset prices. If we had lower private debt to gdp we would have more affordable housing.


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