From a blurb by Krugman discussing a new paper by himself and Gauti Eggertsson:
We ... model a crisis like the one we now face as the result of a “deleveraging shock.” For whatever reason, there is a sudden downward revision of acceptable debt levels – a “Minsky moment.” This forces debtors to sharply reduce their spending. If the economy is to avoid a slump, other agents must be induced to spend more, say by a fall in interest rates. But if the deleveraging shock is severe enough, even a zero interest rate may not be low enough. So a large deleveraging shock can easily push the economy into a liquidity trap.
If debts are specified in nominal terms and a deleveraging shock leads to falling prices, the real burden of debt rises – and so does the forced decline in debtors’ spending, reinforcing the original shock. [So, during a deleveraging schock,] a lower price level will actually reduce demand for goods and services.
More broadly, large deleveraging shocks land the economy in a world ... where many of the usual rules no longer apply. The traditional... paradox of thrift – in which attempts to save more end up reducing aggregate savings – is joined by the “paradox of toil” – in which increased potential output reduces actual output, and the “paradox of flexibility” – in which a greater willingness of workers to accept wage cuts actually increases unemployment.
In the current policy debate, debt is often invoked as a reason to dismiss calls for expansionary fiscal policy as a response to unemployment; you can’t solve a problem created by debt by running up even more debt, say the critics. Households borrowed too much, say many people; now you want the government to borrow even more?...
Ignoring [foreign debt], or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person's liability is another person's asset.
It follows that the level of debt matters only because the distribution of that debt matters, because highly indebted players face different constraints from players with low debt. ...which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past.