Debt and super/hyper inflation

Thespoofer

For example if I borrow to buy an asset at say €25-30k at current interest rates.
In the case of super/hyper inflation happening, what way would a typical debt like so pan out ?

SBWife

Fixed or floating?

andrew

The debt retains its nominal value, while presumably your wages increase in line with inflation. So the actual burden of the debt falls. However, if the interest rate on the debt can change, then the interest payments may increase in and keep the burden of the debt constant.

billyknowsbest

Can anybody explain Irving Fisher's debt deflation explanation for the Great Depression. There is over- indebtedness and falling prices- very low inflation. Fisher says that there is debt liquidation which leads to distress selling- but why? Why liquidate debts and what exactly does this mean. Fisher then says 'there is a contraction of deposit currency as bank loans are paid off- why? And what does this mean exactly?

andrew

I'm no expert but I'll give this a shot.
Insofar as paying down debt reduces the quantity of money in circulation, it takes a bit of understanding regarding how banks create 'commercial bank money'. See this paper. It explains how paying down debt reduces the amount of commercial bank money in the economy.
That debt liquidation leads to distressed selling refers to people clamoring to pay off their debts, by selling their assets at fire sale prices.
Then there's a reduction in the quantity of money, and according to the quantity theory of money, since M falls P has to fall too. To be honest I'm not sure I get how he goes from the velocity slowing to the price level falling, but I take it fischer's paper has a fuller explanation.
The price level falls, and so businesses get less revenue. I don't think this is particularly intuitive, I presume Fisher's paper actually explains the mechanism by which the price level fall leads to falls in revenue (exchange rate effects or what?). But anyway, profits fall, and this leads to unemployment, general gloom, and various feedback loops which cause changes in interest rates (which he defines in a very specific way which I don't understand) and which further the falls in economic activity.
The key takeaway here in any case is that according to Fischer the economy won't naturally adjust to a 'good' path, but continues down one which makes things worse. At best, it comes to an equilibrium only after everyone is severely worse off. That is, until there's some kind of intervention, which when Fischer was writing wasn't really a thing. Now, we have Central Banks and Fiscal authorities (i.e. governments) to provide exactly that kind of intervention.

As an aside, and this isn't in response to anything you said, papers like his are exactly the reason Economics has become mathematical. He takes pages to explain exactly the kind of mechanism he has in mind, because describing mechanisms in terms of mathematical equations again wasn't really a thing at the time. Look at page 343! What a mess!

billyknowsbest

Cheers Andrew- thnaks for taking so much time- I kinda got it but it's the debt liquidation that gets me a bit. People are fire selling- but where will they put that money- into a bank- surely this leads to more cash on deposits in commercial banks??

andrew

It's very counter intuitive, but actually when you pay down a loan at your bank, you reduce the money supply not increase it. The paper I linked explains it better than I can! Basically, you can think of the bank using your money to reduce the size of the asset they have on their balance sheet, making it disappear.

petethedrummer

billyknowsbest wrote: »

Cheers Andrew- thnaks for taking so much time- I kinda got it but it's the debt liquidation that gets me a bit. People are fire selling- but where will they put that money- into a bank- surely this leads to more cash on deposits in commercial banks??

Banks don't lend out deposits.

billyknowsbest

Peterthedrummer- no, but don't the lend out cash to customers based on their deposits- put simply no deposits- no loans. Fractional reserve banking? A % of a bank's deposits is kept in the vaults- the reserve requirement- the rest can be lent out- I vaguely recall an intro to economics course I did years ago and this was called the credit multiplier.

petethedrummer

billyknowsbest wrote: »

Peterthedrummer- no, but don't the lend out cash to customers based on their deposits- put simply no deposits- no loans. Fractional reserve banking? A % of a bank's deposits is kept in the vaults- the reserve requirement- the rest can be lent out- I vaguely recall an intro to economics course I did years ago and this was called the credit multiplier.

The money multiplier is a flawed description of how bank lending operates.

The reserve requirement is really just an amount of money that a bank needs to hold to cover interbank settlements each evening as money flits between banks due to economic activity...... well..... sort of..... if a bank doesn't have the reserves they can borrow from another bank to cover it or they can go to the Central Bank. So there is essentially no reserve requirement.

Bank lending is not really contrained by deposits. If anything it is the opposite. Lending creates deposits.

If you don't believe me then you can read this report by the Bank of England.
http://www.monetary.org/wp-content/uploads/2016/03/money-creation-in-the-modern-economy.pdf
Shame it took until 2014 for the Bank of England to figure out how money operates! Though I'm not convinced by the conclusion that monetary policy limits the growth of credit creation or that QE has any effect on an economy outside of a placebo(1). But I suppose they have to talk up their own effectiveness.

This is a good video on how it works.
https://www.youtube.com/watch?v=KvpbQlQwl0A
All 6 videos in the series are worth a watch. And though I'm not fully behind Positive Money's campaign and solutions to the system, they do the best job of explaining it.

(1) It depends on how you define quantitative easing.

billyknowsbest

Peterthedrummer- many thanks for all that- I look forward to having a look at this in more detail. Does this ultimately mean that if people didn't deposit money with banks, they'd still be able to lend out money?