you're assuming that the government must step in to renominate those debt contracts. consider this: you're an economic agent owed a debt when this happens. Your debtor gives you two options: 1) you hold them to their original contract, they default, you get nothing. OR 2) you renegotiate and at least get some of your money.
part of the problem with the current crisis is indeed "stickiness". That is, people refusing to renegotiate. Why should we reward such behavior?
The "stickiness" is not a result of stubbornness, its a result of how the deflation cascades through the economy. Let's make the scenario even more clean. Imagine overnight a virus runs through computers of the banking system, switches the furthest one to a zero in everyone's account, and thus cuts everyone's savings in half.
The next morning, everyone wakes up, realizes that that their savings is much lower, and that they therefore must cut back on expenses. But they won't cut evenly across the board. They will cut spending on cars, hdtv's, and travel. They'll spend roughly the same amount as always on rice, eggs, water, gasoline to get to work, trash pickup, etc. The manufacturing companies respond by laying off millions of workers. Some of the companies go out of business. As the unemployment rate rises, it puts downward pressure on the wages in the sectors that are still producing at full capacity. This results in wages gradually coming down. As wages come down, the price of products come down. As the price of products come down, people now have money for luxuries. Entrepreneurs buy up the factories and restart car production. Eventually the system rebalances. At the end up the reblancing, the structure of production is the exact same as the structure before the crisis. The only difference is that the price of everything from cars to wages will have dropped to 1/2 the original level.
The government can avoid the whole mess, the whole two or three year cycle of unemployment, by just flipping the bit back and restoring everyone's account to the original level. To not do so, and force the economy through wrenching liquidation and layoffs, would be insane.
Ordinarily, I do not believe the government should rewrite contracts. Nor am I a fan of fiat currencies. But we have a world of fiat currency. And in a fiat currency, the government has a responsibility to prevent a hyperinflation or a hyperinflation. And if the government has been complicit for decades while counterfeit bills circulate through the economy, and all the contracts, business plans, personal budgets, etc depend on those counterfeit bills being tradable, 1 for 1, with federal reserve notes, than the government should do the right thing and allow people to trade in their counterfeit notes for FRN's, rather than allowing a catastrophic deflation to tear through the economy.
a crisis like this can't exist in a vacuum. dumping money on an economy doesn't magically making people's labor less valuable, neither does disappearing a bunch of money. the only reason it has an effect is because of aforementioned stickiness. labor values are relative to one another not absolute.
then you identify the root cause but shy away from it. how would this crisis happen without fiat money in the first place? large amounts of some commodity with inelastic demand would have to be dumped on the market at once (or taken away).
Fiat currency is the cause of the problem, but it also provides the solution. I agree that our financial system should be running MacOS, not windows. I agree that running Windows is why we get so many bugs and viruses. But as long as we are running Windows we should still apply the patches that Microsoft sends us. Or in this case Bagehot. And declaring that we should just let the virus wipe out our computers, so then we can all buy Macs, is neither an effective strategy for making friends and influencing people, nor is it in your interest.
If you're going to run a fiat currency, try and keep it as close to gold-like as possible. Do not inflate, do not deflate. If bug in the banking system wipes out half the currency in the world, simply run a patch to add the money back. If you find some alchemist created gold in a laboratory and pushed it into the market, you should shut down the alchemists lab, but allow the gold that has already entered circulation to continue circulating.
the best way to make fiat currency like gold would be to stop inflating entirely, print no more dollars. the whole point of gold is that supply is relatively INelastic. That is it does not respond to fluctuations in demand. This is what leads to stability, stability leads to confidence about investing for the future.
part of the problem with the current crisis is indeed "stickiness". That is, people refusing to renegotiate. Why should we reward such behavior?