Technical Report Asset Prices and Leverage in a Model of Persistent Stagnation

Schlegl, Matthias  ,  Ono, Yoshiyasu  ,  Illing, Gerhard

988pp.1 - 46 , 2016-12 , The Institute of Social and Economic Research, Osaka University
Why do advanced economies fall into prolonged periods of economic stagnation? What is the role of asset prices and private sector indebtedness for the transition to and the severity of stagnation? In this paper, we present a stylized money-in-the-utility model with a housing sector and financial imperfections to study the interactions between household debt, liquidity and asset prices in an economy with persistent deation and stagnation. Stagnation occurs in equilibrium when a subset of households has insatiable liquidity preferences and hence prefers to hoard cash over consuming. We show that financially more advanced economies are more likely to enter into persistent stagnation. In addition, stagnation is more severe the higher private sector indebtedness. Moreover, credit or asset price booms can mask the underlying structural transition of an economy into stagnation in the short run though at the costs of severing the stagnation in the long run. These findings are in line with the macroeconomic developments in Japan during its lost decades and other major advanced economies during the Great Recession.

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