Richard Koo’s balance sheet recession theory makes some interesting claims that should be bad news for everyone that’s sure inflation is right around the corner, and betting on it.
It is Koo’s belief that inflation does not have to rise along with deficits and the printing of more money.
- When the private sector is choosing to pay down its debt and make savings, the government has to step in to fill the gap.
- If it is the only borrower, it needs to keep spending or the system will stop moving, and the country will face economic contraction. This is what happened in Japan, when the government attempted to cut its deficit in 1997 and 2001.
- But that increase in government spending would, under normal economic rules, lead to inflation as there is an increase in the money supply. Instead, banks use the additional money in the system to pay down their debts, not providing it for private spending through loans.
- Private companies also follow a similar path, paying down debts rather than spending.
- With little money actually being spent, on things like higher wages or goods and services, the value of money maintains while the system pays down its debts.
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