Japan 1990–2005 For example, economist Richard Koo wrote that Japan's "Great Recession" that began in 1990 was a "balance sheet recession". It was triggered by a collapse in land and stock prices, which caused Japanese firms to have
negative equity, meaning their assets were worth less than their liabilities. Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. Corporate investment, a key demand component of GDP, fell enormously (22% of GDP) between 1990 and its peak decline in 2003. Japanese firms overall became net savers after 1998, as opposed to borrowers. Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In his view, this avoided a U.S. type
Great Depression, in which U.S. GDP fell by 46%. He argued that monetary policy (e.g., central banks lowering key interest rates) was ineffective because there was limited demand for funds while firms paid down their liabilities, even at near-zero interest rates. In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy. Koo wrote in 2010 that firms may switch from a
profit maximization objective to debt minimization until they are solvent (i.e., equity is positive). This may take a long time; when the bubble burst in 1990, corporate demand for funds immediately collapsed, and by 1995, the demand was negative, meaning that Japanese companies were making net pay downs of their debt. The demand remained negative for 10 years, until 2005. This happened despite near zero interest rates.
United States 2007–2009 Economist
Paul Krugman wrote in 2014 that "the best working hypothesis seems to be that the
financial crisis was only one manifestation of a broader problem of excessive debt--that it was a so-called "balance sheet recession". U.S. household debt rose from approximately 65% GDP in Q1 2000 to 95% by Q1 2008. This was driven by a housing bubble, which encouraged Americans to take on larger mortgages and use home equity lines of credit to fuel consumption. Mortgage debt rose from $4.9 trillion in Q1 2000 to a peak of $10.7 trillion by Q2 2008. However, it has fallen since as households deleverage, to $9.3 trillion by Q1 2014. While U.S. savings rose significantly during the 2007–2009 recession, both residential and non-residential investment fell significantly, approximately $560 billion between Q1 2008 and Q4 2009. This moved the
private sector financial balance (gross private savings minus gross private domestic investment) from an approximately $200 billion deficit in Q4 2007 to a surplus of $1.4 trillion by Q3 2009. This surplus remained elevated at $720 billion (~$ in ) in Q1 2014. This illustrates the core issue in a balance sheet recession, that an enormous amount of savings was tied up in the banking system, rather than being invested. The decline in housing prices also caused U.S. household equity to plummet, from a peak of $13.4 trillion in Q1 2006 to $6.1 trillion by Q1 2009, a 54% decline. Household equity began to rise after Q4 2011 and was back to $10.8 trillion by Q1 2014, approximately 80% of its pre-crisis peak level. Such a decline in equity shifts household behavior towards
deleveraging, as indicated by the reduction in mortgage balances since Q2 2008 described above. A July 2012 survey of balance sheet recession research reported that consumer demand and employment are affected by
household leverage levels. Both durable and non-durable goods consumption declined as households moved from low to high leverage with the decline in property values experienced during the
subprime mortgage crisis. In other words, according to the
accounting equation, as the value of their primary asset (homes) fell, mortgage debt initially remained fixed, so equity also fell, causing the ratio of debt to equity (a measure of leverage) to rise. This sudden increase in leverage, causing consumers to shift from spending to paying down debt, can account for a significant decline in employment levels, as employers cut back due to concerns of lower consumer demand. Policies that help reduce mortgage debt or household leverage could therefore have stimulative effects. Economist
Martin Wolf wrote in 2012 that the financial crisis in the U.S. was a balance sheet recession: "The overall story, then, is of an economy driven not by fiscal policy decisions, but by private sector decisions taken for reasons that have nothing to do with the long-run fiscal prospects of the economy. Meanwhile, the government, as a whole, was driven into huge deficit by these private sector decisions. That is exactly what one expects to happen in a huge balance-sheet recession, such as this one." Economists Atif Mian and Amir Sufi wrote in 2014 that: • Historically, severe economic downturns are almost always preceded by a sharp increase in household debt. • U.S. household spending declines were largest in geographic areas with a combination of higher household debt and larger housing price declines. • When housing prices fall, poorer homeowners (with a larger proportion of their net worth in their home) are hit the hardest financially and reduce their consumption relatively more than wealthier households. • Declines in residential investment preceded the recession and were followed by reductions in household spending and then non-residential business investment as the recession worsened.{{cite book ==Policy response==