Robert Skidelsky is a member of the British House of Lords, Professor Emeritus of Political Economy at Warwick University, and the author of a prize-winning three-volume biography of John Maynard Keynes. He began his political career in the Labour party, was a founding member of the Social Democratic Party, and served as the Conservative Party’s spokesman for Treasury affairs in the House of Lords until he was sacked for his opposition to NATO’s 1999 bombing of Kosovo. Since 2001, he has sat in the House of Lords as an independent. He has also served as a non-executive director of the American mutual fund Janus (2001-11) and the private Russian oil company PJSC Russneft (2016-21). He is the author of The Machine Age: An Idea, a History, a Warning (Allen Lane, 2023).
Recently I was asked a very reasonable question. When households and firms are deleveraging, why should this decrease demand? Intuitively, when one household decides to pay back debt, that household’s wealth decreases and the wealth of the creditor increases. While the debtor can spend less, the creditor can spend more.
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Lending is a transfer between lenders, who have more money than they wish to spend, to borrowers, who wish to spend more than their current income. It does not follow that if borrowers pay back lenders, the lenders will then spend more. We need to distinguish between asset swaps and spending decisions. The borrower wants to reduce debt and decides to consume less to do so. The lender therefore has cash instead of loans on the books – but that does not mean he or she will spend more. In fact, the recipient is likely to hoard the money paid back if there is an increase in economic uncertainty, in which case the transfer of asset leads to a fall in demand. This is exactly what the banks have been doing in the recent crisis.