Thursday, May 7, 2009
Debt and Deflation
The banes of credit crises are debt and deflation. Debt is the destruction a credit crisis leaves in its wake. Attempting to liquidate it can result in deflation and the ridigity of debt then results in a vicious cycle. Since deflation increases the real interest rate, it makes it more difficult to repay debt while making it more imperative to do so, leading to more liquidation through default or reduction, and more deflation. Deflation must be prevented and debt defused over time. Reasonable inflation can help defuse it, allowing debt to be liquidated and easing the drag on the economy from it.