The indebted demand problem

Savings can infinitely grow whereas debt is limited by borrowers' service capacity.

The indebted demand problem has been producing financial crises since 1980s.

As income distribution changes in favor of the top 1% of the population, the rest has to surge debt to store the top 1%'s savings.

The permanently surging private debt induces financial crises, rendering borrowers fragile.

The indebted demand and liquidity trap

In his thread, Atif Mian explains the indebted demand problem in an economy producing apples and oranges. Mian's illustration reifies how the indebted demand may lead to an output below the production capacity of an economy. Atif Mian's real economy produces apples and oranges. Some people such as Jeff Bezos earns too many of them; so they save most of their apples and oranges. As they cannot store apples and oranges for years, they lend them to Janes to consume now and bring more in the future.

Nevertheless, Jeff's surging savings make the debt relationship unsustainable. Jeff requests a lower interest rate to continue this relationship. Nevertheless, interest rates cannot go way below zero as Jeff at least seeks to nominally conserve his savings. When interest rates hit the zero lower bound, Jeff cannot convince Jane to pile on debt anymore. This is how Atif Main defines the liquidity trap. Realization of the full production capacity of the economy hinges on surging private debt as long as Jeff piles on savings. Atif Mian calls this ''indebted demand problem''.

How does private debt induce financial crises?

The indebted demand problem does not arise merely at the liquidity trap when interest rates hit the zero lower bound. Jane's additional borrowing does not only depend on her willingness to borrow more. Jane has a debt service capacity. Even tough she is willing to borrow more, her income level may not allow her to surge more debt. Convincing her to take additional debt through lower interest rates would make her vulnerable against income shocks. In an economic downturn, over-leveraged Janes collectively default on their debt.

Jane's default on debt wipes out Jeff's savings. This situation is called a financial crisis. Jeff does not lend to Jane not to lose more. However, Jeff's savings can only be stored by means of lending. When Jeff's savings are not consumed by Jane due to the blockage of lending, the economy does not produce at full capacity. Both sides lose income, as a result.

Money's magic can resolve the indebted demand problem by breaking the reliance of personal savings on debt. Jeff could save his savings in cash or more conveniently at the central bank (central bank digital currency) without involving debt. But, then, how could Jane consume Jeff's apples and oranges without borrowing from him? Generating income is not a big deal in a fiat money economy. The central bank would type money and transfer to Jane. Hence, Jane would buy Jeff's apples and oranges without extending new debt. Thus, Jeff could sustainably surge savings at the central bank accounts.

It is not Jeff's surging savings but their involvement in debt which raises fragilities in the financial system. Savings can infinitely grow whereas debt is limited by borrowers' service capacity. Therefore, the connection between savings and debt has to be broken. Thankfully, central bank digital currency (CBDC) is able to serve such a purpose.

Conclusion

The indebted demand problem has been producing financial crises since 1980s. As income distribution changes in favor of the top 1% of the population, the rest has to surge debt to be able to consume the top 1%'s apples and oranges. The permanently surging private debt induces financial crises, rendering borrowers fragile. Replacing private debt with income is in the interest of both Jeff and Jane. Jeff would not bear Jane's default risk to store his savings whereas Jane would not surge debt to consume Jeff's apples and oranges. Happy ending.