Balance Sheet Recession
A recession caused by widespread private-sector debt reduction after a financial bubble bursts, leaving borrowers focused on repaying debt rather than spending.
What is Balance Sheet Recession?
A balance sheet recession is a type of economic downturn that occurs when a large portion of the private sector simultaneously focuses on paying down debt rather than spending or investing, typically after the collapse of an asset price bubble that leaves companies and households with liabilities exceeding the value of their assets. Coined by economist Richard Koo, the concept explains why conventional monetary policy — cutting interest rates — may be ineffective during such recessions: businesses and consumers refuse to borrow at any interest rate when their priority is repairing damaged balance sheets. Koo argued that only large-scale fiscal stimulus can replace the collapsed private-sector demand during these episodes.
Example
Richard Koo applied the balance sheet recession framework to Japan's 'Lost Decade' following the 1990 real estate and equity collapse. Despite near-zero interest rates throughout the 1990s, Japanese companies used cash flow to repay debt rather than invest, causing prolonged stagnation that only government spending partially offset.
Source: Richard Koo — The Holy Grail of Macroeconomics (2008)