Bank credit, expected inflation rate, and financial dynamics

Abstract

We investigate the effects of debt–capital ratio and expected inflation rate on the stability of the economy using a Minsky model and reconsidering Fisher’s debt-deflation theory. We have developed static and dynamic models that formalize an inflation-targeting policy. The static model reveals that an increase in the debt–capital ratio may negatively impact the profit rate and that the Fisher proposition is invalid. Our dynamic model indicates that the economy can become endogenously unstable. When the debt–capital ratio is high and the sensitivity of nominal wage rate to the profit rate is higher than that of bank lending, it may lead to debt-deflation. Finally, we demonstrate that the central bank alone can make only a limited contribution to economic stability.