Asset Deflation and Financial Fragility

Abstract

The purpose of this paper is quite modest. The theoretical argument starts by accepting Keynes’s fundamental axiom that money is never neutral in an entrepreneurial economy.¹ It is then possible to trace out why, if all prices are flexible, falling prices and especially an asset price deflation can have a devastating impact on the financial system and permanently lower employment and real economic growth. (If, on the other hand, money was neutral, then falling prices would be the process through which the economic system either maintains or restores full employment prosperity.)

This paper was published in Money and Banking — Issues for the Twenty-First Century, by P. Arestis (ed.) (London: Macmillan, 1993).