Keynesian Deflation Phobia Leads to an Exaggerated View of Balance Sheet Recession Danger

Let's turn to a further source of Keynesian phobia about deflation--balance sheet recessions. In severe cases of deflation phobia, this concern might even extend to the essential rhythm of prices both in a downward and upward direction which would be evident in a well-functioning capitalist economy under conditions of monetary stability (including a fixed anchor to prices in the very long run). Balance sheet recessions were first analysed by Irving Fisher in the context of the Great Depression and have been made much of by some inflation target proponents such as Bernanke (2000). Their trumpeted fear is that the fall in the price level would bring an increase in the real indebtedness of businesses which would hinder their prospects of weathering the recession and moving forward to take advantage of new investment opportunities.

The antidote to this fear is the realization that the recovery of the price level further ahead (beyond the present fall related to recession or start of secular stagnation) will go along with a decline in the real value of the debt (or equivalently there will be a period of substantially negative real interest rates) offsetting the rise in real value during the price fall. . . .

In sum, the harmful balance sheet effects of deflation (rising real indebtedness) only appear where markets fail to put any significant weight on a possible later price level recovery--meaning that substantially negative real interest rates do not emerge.

--Brendan Brown, A Global Monetary Plague: Asset Price Inflation and Federal Reserve Quantitative Easing (Houndmills, UK: Palgrave Macmillan, 2015), Kobo e-book.