The Age of Balance Sheet Recessions:

What Post-2008 U.S., Europe and China

Can Learn from Japan 1990-2005

Richard C. Koo
Chief Economist
Nomura Research Institute
Tokyo
April 2010
Exhibit 1. US Housing Prices Are Moving along
the Japanese Experience

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Exhibit 2. Drastic Rate Cuts Have Done Little to Revive
Economies or House Prices

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Exhibit 3. Bursting of the Housing Bubble Weakened the US Economy

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Exhibit 4. Bursting of the Housing Bubble Weakened
European Economies

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Exhibit 5. US Demand for Funds Is Falling even with
Zero Interest Rates

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Exhibit 6. Euro Zone Demand for Funds Is Falling even with
Ultra-low Interest Rates

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Exhibit 7. Japan’s De-leveraging with Zero Interest Rates
Lasted for 10 Years
Funds Raised by Non-Financial Corporate Sector

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 Exhibit 8. Features of Balance Sheet Recession

  A balance sheet recession emerges after the bursting of a debt-

financed asset price bubble that leaves many private-sector
balance sheets with more liabilities than assets.
  In order to repair their balance sheets, private sector moves
away from profit maximization to debt minimization.
  Private sector de-leveraging, even with zero interest rates,
means there will be no borrowers of newly generated savings
and debt repayments. With no borrowers, the economy will
continue to loose aggregate demand equivalent to the sum of
un-borrowed savings and debt repayment.
  The economy will not enter self-sustaining growth until private
sector balance sheets are repaired.
  Fiscal consolidation should begin only after it is ascertained that
funds NOT borrowed by the government will be borrowed and
spent by the private sector.

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Exhibit 9. Japan’s GDP Grew even after Massive Loss of Wealth and
Private Sector De-leveraging

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Exhibit 10. Japanese Government Borrowed and Spent the
Excess Savings of the Private Sector to Sustain GDP

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 Exhibit 11. Large Deficits Do Not Mean Higher Interest Rates if the
Government Is Borrowing and Spending Excess Private Sector Savings*

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Exhibit 12. Financial Surpluses of US Households
Are now Greater than that of Japanese Households

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Exhibit 13. UK Private Sector Financial Surpluses
Are Increasing Sharply

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Exhibit 14. Premature Fiscal Reforms in 1997 and 2001 Weakened
Economy, Reduced Tax Revenue and Increased Deficit

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Exhibit 15. Short and Long Term Trends of Global Economy

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 Exhibit 16. Four Kinds of Banking Crises and their Remedies

Type (I): 1989 S&L crisis

Type (II): 1982 Latin America debt crisis, nationwide credit crunch in the US between
1991 and 1993, and the Nordic banking crisis in the early 1990s

Type (III): Japan prior to 1995 (for example, problems at two credit cooperatives)

Type (IV): Japan since 1996, Taiwan since 2000, the US Great Depression of the
1930s, and US and UK subprime crisis since 2007
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession, John Wiley & Sons, Singapore, 2008

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Exhibit 17. Japanese Banks Took Losses on NPIs Quickly

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Exhibit 18. Inflation a Distant Prospect: Monetary Aggregates Behave
Differently under Balance Sheet Recession
Japan

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Exhibit 19. Inflation a Distant Prospect: Monetary Aggregates Behave
Differently under Balance Sheet Recession
US

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Exhibit 20. Japan’s Money Supply Has Been Kept Up
by Government Borrowings

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Exhibit 21. Post-1933 US Money Supply Growth Was also Made
Possible by Government Borrowings
Balance Sheets of All Member Banks

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Exhibit 22. New Deal Policies Doubled Fiscal Expenditures
without Increasing Budget Deficit*

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Exhibit 23. German Fiscal Stimulus Reduced
Unemployment Dramatically

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 Exhibit 24. The Exit Problem: Debt Rejection Syndrome
It Took US 30 Years to Normalize Interest Rate after 1929

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 Exhibit 25. Yin Yang Cycle of Bubbles
and Balance Sheet Recessions

US

Spain

UK

Germany

Japan

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Exhibit 26. Contrast Between Yin and Yang Phases of a Cycle

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