Pigou's Wealth Effect Suggests That When the Price Level Falls

Essay

Pigou's wealth effect suggests that when the price level falls, consumers feel wealthier and so increase their spending.Another implication of falling prices, however, is that the real value of dollar-denominated debts will increase.For example, if you owe $100, the real value of your debt goes up, and you are worse off.If someone owes you $100, then falling prices make you better off.Now suppose that on average those who borrow money tend to spend a larger fraction of their income than do those who lend money.Will spending rise or fall as a result of a fall in the price level?