Balance Sheet Recessions and the Global Economic Crisis

Richard Koo

Chapter Chapter 4 in Economic Reform Now, 2013, pp 85-131 from Palgrave Macmillan

Abstract: Abstract Economists in the United States, Europe, and Japan differ sharply on what constitutes the correct policy response to the economic crisis. This divergence in views stems from the fact that these economies are suffering from a rare type of recession, which has largely been overlooked by the economics profession. Economists, who constructed elaborate theories based on the assumption that the private sector would always aim at maximizing profits, never anticipated the scenario of a private sector seeking to minimize debt. But when a debt-financed asset price bubble bursts, the private sector is left with a huge debt overhang, and to climb out of this state of negative equity it must pay down debt or increase savings, even if interest rates are zero. When the private sector as a whole is minimizing debt, the economy continuously loses aggregate demand equivalent to the saved but unborrowed amount. This situation has come to be known as a balance sheet recession.

Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:pal:palchp:978-1-137-36407-4_4

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DOI: 10.1057/9781137364074_4

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