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One remedy to a liquidity trap is expanding the money supply via quantitative easing or other techniques in which money is effectively printed to purchase assets, thereby creating inflationary expectations that cause savers to begin spending again.Government stimulus spending and mercantilist policies to stimulate exports and reduce imports are other techniques to stimulate demand.The term balance sheet derives from an accounting identity that holds that assets must always equal the sum of liabilities plus equity.If asset prices fall below the value of the debt incurred to purchase them, then the equity must be negative, meaning the consumer or corporation is insolvent.
This may be triggered by various events, such as a financial crisis, an external trade shock, an adverse supply shock or the bursting of an economic bubble.In theory, near-zero interest rates should encourage firms and consumers to borrow and spend.However, if too many individuals or corporations focus on saving or paying down debt rather than spending, lower interest rates have less effect on investment and consumption behavior; the lower interest rates are like "pushing on a string." Economist Paul Krugman described the U. 2009 recession and Japan's lost decade as liquidity traps.Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. 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.Corporate investment, a key demand component of GDP, fell enormously (22% of GDP) between 1990 and its peak decline in 2003. Krugman discussed the balance sheet recession concept during 2010, agreeing with Koo's situation assessment and view that sustained deficit spending when faced with a balance sheet recession would be appropriate.
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Japan’s 1993–94 recession was U-shaped and its 8-out-of-9 quarters of contraction in 1997–99 can be described as L-shaped.