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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. He argued that monetary policy was ineffective because there was limited demand for funds while firms paid down 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. 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.If asset prices fall below the value of the debt incurred to purchase them, then the equity must be negative, meaning the consumer or corporation is insolvent.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." In Krugman's view, such crises require debt reduction strategies combined with higher government spending to offset declines from the private sector as it pays down its debt.Too many consumers attempting to save (or pay down debt) simultaneously is called the paradox of thrift and can cause or deepen a recession. Federal Reserve Vice Chair Janet Yellen discussed these paradoxes: "Once this massive credit crunch hit, it didn’t take long before we were in a recession.Economist Hyman Minsky also described a "paradox of deleveraging" as financial institutions that have too much leverage (debt relative to equity) cannot all de-leverage simultaneously without significant declines in the value of their assets. The recession, in turn, deepened the credit crunch as demand and employment fell, and credit losses of financial institutions surged.A recession has many attributes that can occur simultaneously and includes declines in component measures of economic activity (GDP) such as consumption, investment, government spending, and net export activity.These summary measures reflect underlying drivers such as employment levels and skills, household savings rates, corporate investment decisions, interest rates, demographics, and government policies. Koo wrote that under ideal conditions, a country's economy should have the household sector as net savers and the corporate sector as net borrowers, with the government budget nearly balanced and net exports near zero.
Japanese firms overall became net savers after 1998, as opposed to borrowers. However, Krugman argued that monetary policy could also affect savings behavior, as inflation or credible promises of future inflation (generating negative real interest rates) would encourage less savings.
When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people." High levels of indebtedness or the bursting of a real estate or financial asset price bubble can cause what is called a "balance sheet recession." This is when large numbers of consumers or corporations pay down debt (i.e., save) rather than spend or invest, which slows the economy.