An economic downturn characterized by the private sector prioritizing debt repayment over spending and investment, even when interest rates are low and credit is available. This behavior typically follows the bursting of an asset bubble, when households and corporations find their balance sheets impaired by falling asset values while liabilities remain unchanged. The concept was popularized by economist Richard Koo to explain Japan's prolonged stagnation in the 1990s and highlights why traditional monetary policy can be ineffective when borrowers focus on deleveraging rather than borrowing.
Example
“After the housing crash, the economy entered a balance sheet recession as households used any extra income to pay down mortgage debt instead of increasing consumer spending.”