Debt Deflation Hypothesis

The Debt-Deflation Theory was described by Irvin Fisher as an interactive process whereby falling commodity prices increased the debt burden of borrowers.

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In the period of the 1920s there was a widespread use of the home mortgage and credit purchases of durable goods that boosted spending, but increased consumer debt. When a price deflation occurred people who were deeply in debt were in serious trouble because they risked default. In turn, consumers dramatically cut current spending to keep up with their payments, which resulted in lowering the demand for new products.

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Debt in the United States also became heavier because prices and incomes fell 20-50%, but the dollar amount of the debt remained the same, making it more difficult to pay back. Capital investment slowed down and almost completely ceased because future profits looked poor and pressure from creditors. In turn, banks became more conservative in lending and built up their capital reserves, which intensified the deflationary pressures. This also led to the investment ration to fall because of the expectation of poor profits.

Great Depression What

Contractionary Issues

The Gold Standard Monetary Policy