Debt deleveraging, debt Relief and liquidity traps

I study debt relief policies during debt-driven slumps using a model of deleveraging. Deleveraging can push the economy into a liquidity trap characterized by involuntary unemployment and low inflation. A debt relief policy, captured by a transfer of wealth from creditors to debtors, increases aggregate demand, employment and output. Debt relief may benefit creditors as well as debtors and lead to a Pareto improvement in wel-fare. The benefits from a policy of debt relief are greater the more the central bank is concerned with stabilizing inflation. Moreover, targeting inflation during a liquidity trap can generate multiple equilibria. In this case it is possible to design debt relief policies that eliminate undesirable equilibria