What happens if enterprises also actively save? -Part 1

Si Gyeongmin

Nov 17, 2021

Theoretical logic of balance sheet recession

The logic of the balance sheet recession is relatively simple. When the economy is in an upward cycle, optimism permeates the entire market. Enterprises in the economy borrowed and accumulated a large amount of debt. In the process, asset bubbles appeared in some areas (real estate, stocks). Due to policy or other reasons, the asset bubble was punctured, and the balance sheet of the enterprise holding the bubble asset was severely impacted. The asset side shrank significantly, but the liabilities did not change significantly, and the enterprise became insolvent, which led to the technical bankruptcy of the enterprise. In order to repair the balance sheet as soon as possible, enterprises will suppress the increase in debt and speed up the repayment of debt. Because enterprises no longer actively borrow, this makes the monetary policy effect of stimulating the economy by lowering interest rates and providing liquidity greatly compromised. The direct inference of this phenomenon is that fiscal policy should play a positive role, and the government should take the initiative to borrow debts and increase spending, so as to avoid the economy from falling into a debt-deflationary cycle.

The key to the establishment of the theory of balance sheet recession is the transformation of business objectives from maximizing profits to minimizing liabilities. Gu Chaoming used the cycle of yin and yang to describe the change of business objectives. In the positive cycle, the goal of the enterprise is consistent with the assumptions in economics textbooks, pursuing profit maximization. But in the negative cycle, the theory of balance sheet recession overturns this assumption and believes that in the case of insolvency, The primary goal of an enterprise is to repay debts as soon as possible and restore the balance sheet to a normal state, rather than continue to borrow and invest and increase profits.

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