Irving Fisher...

This is by Fisher...

           
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To understand the above lines it is important to grasp “how debt could create deflation?” Fisher said deflation is caused by over-debt, therefore we might expect real interest-rates to be high as opposed to only nominal interest-rate, which also has an element of inflation or deflation. Inflation or deflation might increase or lower the real interest-rate which may affect indebtedness. Higher inflation means lower real interest-rate and deflation may increase real interest rate and vice-versa. Fisher, here, is concerned about debt, deflation and higher real interest rate, which might make the currency appreciate that may increase indebtedness because the value of money would increase. However, to decrease over-indebtedness and increase demand/supply, and restore equilibrium, the economic-policy could lower real interest-rate by increasing the price-level. But, to increase the price-level the policy must be able to decrease real interest rate, and not increase it, because that would also lower the price-level by limiting demand/supply, thereby increasing real-interest rate further. To overcome indebtedness the economy might try to reduce real interest rate which might increase the demand/supply and prices.

It is vital to figure-out that how over-indebtedness can increase deflation. Over-indebtedness means higher interest-rate or real interest rate because the monetary-policy would be tightened to control demand/supply and prices. Therefore, to reduce indebtedness real interest-rate might be reduced which would increase demand/supply and prices. Indebtedness would increase real interest rate which could lower demand/supply and prices. Deflation is caused by high debt and real interest rate. Therefore, to control debt, real interest rate might be cut to increase inflation, which would again cut real interest rate.

Nonetheless, zero-lower bound constrains lowering interest rate, but real interest rate could be cut by increasing demand/supply and inflation.

Fisher says high debt or interest rate causes deflation which worsens the debt situation further. Therefore, to tide-over indebtedness real interest rate should be reduced to increase demand/supply and prices. Increasing real interest rate to reduce borrowing would increase deflation which might aggravate the suffering. Debt situation can only be improved by lowering real interest rate and attempts to control debt may result in further misery. Measures aimed to control demand/supply by increasing interest rate would result in even deflation and higher real interest rate.   

This pattern is evident in the US economy where the central-bank has cut interest rate to zero and is trying to increase inflation to reduce real interest rate. Very low interest rate and low prices or deflation has made the Fed to adopt expansionary policy which also makes a strong case for expansionary fiscal-policy because both might be able to increase inflation and lower real interest to increase demand/supply, but low inflation has made the policy-makers pursue expansion longer than expected.

It is still new to my understanding that measure to control debt and inflation by increasing interest rates might further result in indebtedness by increasing disinflation and the real interest rate. Attempts to control debt and inflation may create deflation which economists consider a bigger problem than inflation. However, they say little deflation is not bad as lower prices would increase consumption and savings. Low inflation or deflation would also help to keep interest rates low. Deflation is good for the poor and inflation is good for the capitalist. Lower-prices or deflation would lower the cost of borrowing or interest rate and the general price-level. Lower cost of capital also helps to lower prices to a considerable extent; the capital-cost goes down. And, as we know lower prices or interest rate are more expansionary than inflation and higher interest rate...