A balance sheet recession is a type of economic downturn that occurs when businesses, households, or even governments focus on reducing debt (deleveraging) rather than spending or investing, often after a financial crisis. This leads to reduced consumption and investment, causing a prolonged period of low growth and stagnation.
Key Characteristics:
1. Excessive debt: Before the recession, businesses or households often accumulate high levels of debt, typically during a credit boom or financial bubble.
2. Asset collapse: When asset prices fall (like in a housing or stock market crash), the value of assets held by these businesses or households drops sharply, but the debt remains.
3. Deleveraging: To repair their balance sheets (the difference between assets and liabilities), businesses and households focus on paying down debt rather than spending, investing, or taking out new loans.
4. Low demand: As many sectors of the economy focus on debt repayment, overall demand in the economy decreases, leading to slow growth or contraction.
5. Prolonged recovery: Because spending and investment are subdued for an extended period, these recessions tend to last longer than typical recessions.
Example:
The Japanese recession in the 1990s is a classic example of a balance sheet recession. After the bursting of Japan's real estate and stock market bubbles in the early 1990s, businesses and households focused on debt repayment rather than spending or investing, which caused the economy to stagnate for years.
In summary, a balance sheet recession happens when debt-heavy sectors prioritise paying off debt over consumption and investment, leading to prolonged economic stagnation.
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