Working Paper: NBER ID: w26940
Authors: Atif R. Mian; Ludwig Straub; Amir Sufi
Abstract: We propose a theory of indebted demand, capturing the idea that large debt burdens by households and governments lower aggregate demand, and thus natural interest rates. At the core of the theory is the simple yet under-appreciated observation that borrowers and savers differ in their marginal propensities to save out of permanent income. Embedding this insight in a two-agent overlapping-generations model, we find that recent trends in income inequality and financial liberalization lead to indebted household demand, pushing down natural interest rates. Moreover, popular expansionary policies—such as accommodative monetary policy and deficit spending—generate a debt-financed short-run boom at the expense of indebted demand in the future. When demand is sufficiently indebted, the economy gets stuck in a debt-driven liquidity trap, or debt trap. Escaping a debt trap requires consideration of less standard macroeconomic policies, such as those focused on redistribution or those reducing the structural sources of high inequality.
Keywords: No keywords provided
JEL Codes: D31; E21; E32; E43; E44; E52; E62; G51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high debt levels (F34) | lower aggregate demand (E19) |
| lower aggregate demand (E19) | lower natural interest rates (E43) |
| rising income inequality (D31) | increased indebted demand (F34) |
| financial liberalization (F30) | increased household borrowing (G51) |
| increased household borrowing (G51) | lower aggregate demand (E19) |
| wealthy saving a larger fraction of income (E21) | exacerbated indebted demand phenomenon (F65) |
| debt accumulation (H63) | lower interest rates (E43) |
| policies aimed at boosting demand through debt accumulation (E62) | persistently low interest rates (E43) |
| unconventional policies focused on redistribution (P35) | escape from debt trap (F34) |