AbstractThe collapse of Japanese asset prices in the early 1990s‐which weakened the balance‐sheet positions of banks, firms, and households‐has led some observers to suggest that “balance‐sheet problems” may have contributed to the recent economic downturn and may impede a recovery. In this article, we conclude that balance‐sheet problems did not and will not play a significant role in depressing the Japanese economy. First, while asset prices appear to have some explanatory power in loan demand and supply relationships, we find that asset price shocks in the 1990s had little effect on borrowing and lending, other than through traditional wealth effects on aggregate demand. Second, we find little evidence that bank lending was tighter than usual compared to downturns of the 1990–1993 magnitude. Finally, we find some puzzling evidence that borrowers lowered their appetite for loans, even after accounting for sharp declines in aggregate demand a