Fisher's Debt Deflation Theory
Irving Fisher was an economist who lost a fortune in the Great Depression. His article "The Debt-Deflation Theory of Great Depressions" was published in 1933 to explain the fall of the American economy four years prior. It has been considered a central, seminal paper about depression economics ever since.
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Features
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The basic structure of Fisher's theory is dynamic. Deflation is defined as available money going out of productive circulation, hence reducing the available pool of cash from which investors draw. When there are signs of a weakening economy significant enough to frighten investors, there begins a round of "fear selling" of assets. This becomes a self-fulfilling prophecy as asset prices go down as a result, and money falls away from productive investment. Since asset values fall severely, bankruptcies result and production goes down. Psychologically, this all leads to pessimism,economic inactivity and, significantly, the hoarding of money, continuing the deflationary spiral.
Significance
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By focusing on financial markets, Fisher altered the nature of speculation on the theory of depressions and recessions. Traditionally, "equilibrium" theory ruled the day, which held that even if assets were to decrease in value, this would merely spur the market to begin buying these assets, hence eventually reestablishing their value. This theory might be called "catastrophic" rather than equilibrium, and it altered the nature of economic writing on these subjects. In addition, it became clear that Fisher's stress on the personal and psychological processes of depressions eliminated the optimism of classical liberal economics and brought some much-needed perspective on the often purely abstract and mathematical approaches of professional economists.
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Function
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The main function of Fisher's theory is to comprehend the nature of catastrophic depressions and other severe dislocations in the economic system. The older, liberal equilibrium school refused to countenance catastrophe, given its simple perspective that even the worst of situations means opportunity for others. What Fisher did was to introduce psychology into the picture, holding that once brokers and investors began selling like mad, the value of assets would go down. As people refused to engage in investment, money would be hoarded or used to pay down debt; hence, deflation would result as more and more money went out of regular circulation.
Considerations
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Fisher's relevance to the global depression of 2008--2010 cannot be understated. As of 2010, writers on economic depression have consistently used Fisher's insights, even without realizing it. The shift to financial markets focused attention on the work of traders and brokers, showing for the first time the level of power these actors actually had.
Benefits
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The real benefit to Fisher's approach is that it brings policymakers and the public to a real understanding of global economics. After Fisher, it became more and more difficult for powerful figures in the major investment firms to hide behind abstract concepts such as "the market." They were, as people, largely responsible for what happened.
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References
- Photo Credit Stock Market Crash image by Paul Heasman from Fotolia.com
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Comments
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Time to sell.
