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

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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

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

Germany

Japan

US

UK

Spain

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

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