Richard Koo has a big hammer: it is the idea of the “balance sheet recession” — which happens when the indebted focus on paying down debt. But people with hammers tend to view everything as a nail. Here, the chief economist of the Nomura Research Institute shows the virtues, but also the limitations, of his intellectual tool.

Balance sheet recession is a development of the concept of “debt deflation”, advanced by American economist Irving Fisher during the Great Depression. Fisher noticed that, if the price level falls, the real value of debt will rise. If many people are highly indebted, the economy then risks falling into a vicious downward spiral.

Koo argues that much the same thing will happen after the implosion of a debt-fuelled asset-price bubble even with little (if any) deflation. He had a ringside seat at just such an event in Japan in the early 1990s. The collapse of asset prices shifted the private sector into huge surplus, as income that would otherwise have been spent was devoted to repayment. A shortage of willing and solvent private borrowers rendered low interest rates ineffective. The government had to use fiscal policy, borrowing and spending instead. Moreover, the surpluses of the private sector also allowed the government to borrow easily and cheaply for years.