High levels of indebtedness, past borrowing and financial recklessness can individually or collectively cause what is referred to as a ‘balance sheet recession.’
Essentially, balance sheet recession is when the government and a large number of corporations pay down debt (i.e. save) rather than spend or invest, thereby slowing down the economy.
The term balance sheet is derived from an accounting identity, which states that assets must always equal the sum of liabilities plus equity. In the same manner that our reserves should always equal our indebtedness plus interest payable.
If the value of our assets falls below the value of the debt incurred to purchase them, or if our reserves fall below the interest payable on our debt, then the equity is described as negative, meaning the consumer or corporation or government is technically insolvent.
Economist Paul Krugman wrote in 2014 - "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 a decline from the private sector, as it pays down its debt.
Richard Koo also wrote about Japan's ‘Great Recession’ which began in 1990. He claimed that this was due to a ‘balance sheet recession.’ which was triggered by a collapse in land and stock prices. This caused Japanese firms to have negative equity - meaning their assets were worth less than their liabilities.
It is worth pointing out here that the recession in Nigeria is essentially caused by corruption brought about by huge borrowing by federal and states governments, wasteful utilization of loans, lack of investments, huge debt with aggravating interest rates, unreasonable dependence on oil (compounded by the fall in oil price), dependence on government jobs, and habitual dependency on foreign products as against local products.
To overcome the Japanese recession, Japanese corporations in aggregate opted to pay down their debts from their own business earnings, rather than borrow as firms typically would do. Japanese firms overall became net savers after 1998, as opposed to borrowers.
Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In his view, this avoided a U.S. type Great Depression, in which U.S. GDP fell by 46%. He further explained that monetary policy was ineffective because there was limited demand for funds while firms paid down their liabilities. 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.
SOLUTION - While government is paying its debt from money held in the reserve in order to ‘balance the sheet’, those monies should be released through borrowing. This way, people can invest through their own self-employment, thereby increasing production.
In addition, interest rates should be lowered in order to encourage people to take loans and carry out more investments to keep the economy moving and possibly turn the economy round.
Government should keep up with its plan to encourage development of social amenities, ensure lower interest rates, and see that money is released into the economy through grants and loans to individuals or corporate bodies for the purpose of further increasing production and development.
Kayode Ajulo is a lawyer, notary public and political and humanitarian activist.