General Disequilibrium Analysis with Inside Debt

This paper incorporates inside nominal debt into a Keynesian general disequilibrium model. It shows how nominal wage adjustment may be insufficient to restore Walrasian equilibrium. Nominal wage reductions lower aggregate demand by increasing debt service burdens. This aggravates Keynesian deficient demand unemployment. When there is classical unemployment, falling nominal wages mean that the economy may hit a Keynesian constraint before it attains Walrasian full employment. In situations of repressed inflation, rising nominal wages reduce debt service burdens and increase aggregate demand, thereby worsening the extent of excess demand. JEL ref.: E0, E1