Debt is not a transfer

In this post, Interfluidity talks about how the real sticky price in the world isn't labor, it's debt. This is correct, and is at the heart of Fisher's debt-deflation theory. Fisher's an interesting guy, because after losing all his money during the Great Depression, he actually changed his mind about how the economy works.

In the comments, Nick Rowe jumps in with the standard economic position on debt:

Suppose that last year, I borrowed from you, and promised to pay you $100 this year. Sure, that $100 is “sticky”. But it’s not a price. Last year it was a price (the price we negotiated when you gave me the loan), but it’s not a price this year. It’s not a price like the price of labour or the price of cars. The price of labour or the price of cars affects how much labour or cars we decide to buy or sell at that price. And if those price are sticky and get out of whack that can create excess demand or supply of labour or cars. But that $100 I owe you is a transfer payment. It’s like a welfare payment or social security check. The decision it affected has already been made, last year. It cannot any longer create excess demand or supply, though it could have done last year, if it had been sticky last year. What it does do is transfer resources from me to you. It affects the distribution of wealth. It’s not a measure of the scarcity of goods that people are currently deciding to buy or sell.

This position is incorrect. First, an outstanding loan is not a "transfer". When a bank makes a loan, money is not "transferred" from party A to party B. The loan is made ex nihilo by the bank crediting an asset and liability at the same time, expanding its balance sheet to both create the receivable and the deposit. It is only if the loan is defaulted on that it becomes a transfer, a transfer from the bank's equity holders to the loan recipient. Macroeconomics does not model debt, and therefore does not model the economy in a useful or realistic way.

Second, distribution of wealth very much impacts forward looking decisions, and it impacts the scarcity of goods that people are trying to buy or sell. For example, if a number of loans default, and wealth is distributed from bank equity holders to loan recipients, then the banks are undercapitalized and will not extend new credit. Moreover, bank investors will revise downward their estimation of a bank's skill in making good loans, and will increase the cost of capital if they do decide to make additional investments. All of this impacts the price of credit explicitly, and are entirely distributional outcomes.

Thirdly, willingness to pay decisions in micro are always subject to budget constraints. Wealth distribution impacts this directly again. Only in macro does the amount of money you have play no role in your willingness to spend.