The relationship between monetary policy and debt deflation: Discussions in the literature

Two fundamental facts of importance are encountered in financial crises that play an active role in the global economy, such as the Great Depression of 1929. In this sense, the findings of theoretical and empirical studies have revealed that the relationship between monetary policy and debt deflation channel has a serious role in the financial crisis processes. In this regard, the aim of the study is to investigate the discussions in the theoretical and empirical literature on the relationship between monetary policy and debt deflation in the global economy. As a matter of fact, contributions to the literature in the periods after the financial crises that occurred in the historical process show that debt deflation should have a significant role in monetary policy practices. Monetary policy transmission channels and debt deflation, in addition to affecting the real sector, play an active role in price stability and financial stability in the markets. In this sense, the impact of monetary policy on the real economy, liquidity shortage and the accompanying high real interest rates reveal the weakness in the financial sector as a result of the panics that occurred in the economy not through traditional Keynesian channels, but through the debt deflation channel introduced by Irving Fisher. It is aimed to examine in detail the relationship between monetary policy and debt deflation in explaining global crises such as the Japan crisis in the 1990s, the 2008 Global Financial Crisis and the 2010 European Debt crisis, and to develop appropriate monetary policies in this context. For this purpose, theoretical and empirical discussions in the literature have cumulatively revealed that extreme declines in the general level of prices, rising real interest rates and increasing debt may trigger default risks of households, firms and banks. It has been revealed that increasing default and the accompanying financial risks can lead to various financial crises such as debt crises and banking crises.