The Relationship between High Debt Levels and Economic Stagnation, Explained by a Simple Cash Flow Model of the Economy

Abstract

Empirical data is presented suggesting that high private and, to a lesser extent, public debt levels place a strong drag upon economic growth. A simple, demand-based, cash flow (DBCF) model of the economy is developed, separating out flows by marginal propensity to spend. This approach is both logically sound and empirically consistent with the data and also supports a prognosis for the economy and estimate of future NGDP growth. Importantly, it is a model that is flexible enough to incorporate high debt scenarios, and is able to explain the secular stagnation currently experienced by Western economies and Japan. A simulation is also provided to show the danger to stability of allowing private sector debt to fill lost demand. The conclusion is that the zero lower bound has been reached because there is too much private sector debt for the economy to sustain. Demand is perpetually too low because of structural excess saving. The proposed solution is to rebalance the economy using large, preferably monetised, government deficits.