Eggertsson and Krugman

I don't know how many economists have been reading the new paper by Eggertsson and Krugman.  I just gave it a once over.  I didn't check the math that wasn't obvious but I could see how the equations fit together, and the intuition made sense.

For me, anyway, this model adds a whole lot of clarity to the current situation, many past recessions, and macroeconomics in general.  I feel it is destined to be a classic.

The backward bending AD curve is really interesting.

One thing they didn't mention:  The idea of a threshold level of debt that changes in "the Minsky moment" melds very nicely not only with standard models of asymmetric information (a la Stiglitz and Weiss) but also with the well documented empirical link between risk premiums and business cycles.  When risk, or at least perceived risk, goes up, threshold debt levels naturally decline in asymmetric information models.

The model needs more dynamics.  It would also be nice if the model included both risky and safe assets.  But it seems unlikely that these will change anything substantive.

For me, this makes the link between micro and macro in way that actually makes sense.

Update: By "makes sense" I mean that the model uses a mechanism that draws a more plausible link between the non-bailout of Lehman Brothers, the financial collapse, and the ensuing recession.  Awhile back I speculated that a better model would draw more explicit link between micro asymmetric information models (like Stiglitz and Weiss, which shows how credit rationing occurs) and aggregate demand shocks.

To me anyway, this makes way more sense than real productivity shocks or stochastic laziness as the principal driver of business cycles.  If one were to try and generalize this model by Eggertsson and Krugman, I can imagine there being real shocks in perceived uncertainty that then feeds back into macroeconomy through deleveraging cycles.  So, the source of recessions need not be actual productivity shocks, just some increased uncertainty about the future, which may or may not have anything to do with fundamental productivity.  Even political uncertainty would do.  The real economic effect comes later through the develeraging cycles.

Update:  Nick Rowe has a very nice review of the article.