The Foreign Exchange Origins of Japan's Economic Slump and Low Interest Liquidity Trap

Japan's macroeconomic problem has yet to be properly diagnosed. Throughout the 1990s, policy makers could not decide on the proper macro economic measures to combat the country's severe economic slump. We propose a unified explanation, with deep historical roots, of why aggregate private demand failed to recover after Japan's stock and real estate bubbles burst in 1991 and deflationary pressure continues. The problem is not purely ‘made in Japan’. It arises from Japan's unbalanced mercantile relationship with the United States. Starting in the early 1970s, numerous trade disputes between the two countries created tensions that were (temporarily) resolved by the yen going ever higher against the dollar up to 1995. In the last two decades, this persistent pressure for the yen to rise was further aggravated by Japan's large current‐account (saving) surpluses as the counterpart of America's large current account (saving) deficits. The legacy is the expectation that trade and financial tensions will recur so that the yen will be higher 10, 20, or 30 years from now –with Japan's (wholesale) price level forced correspondingly lower and nominal interest rates on yen assets remaining more than four percentage points less than those on dollar assets. This fear of yen appreciation, whose timing is erratic and unpredictable, now inhibits private domestic investment by both Japanese firms and households. Our theory also explains why, in the late 1990s, nominal interest rates on short‐term yen assets were compressed toward zero so as to destroy the normal profit margins of the banking system. In this liquidity trap, the Bank of Japan –whose monetary policy has been quite ‘expansionary’–is powerless to stimulate the flagging economy. To spring the liquidity trap, eliminate deflationary pressure, and restore macro economic balance in Japan, the American and Japanese governments must act jointly to quash the expectation that the yen will be higher in the future than it is today.     

The RMB Debate: Empirical Analysis on the Effects of Exchange Rate Shocks in China and Japan

For a better understanding of the ongoing debates on the RMB, this paper investigates the effects of exchange rate shocks on output and the current account for China and Japan. We use structural vector auto‐regression models and find that yen appreciation reduces current account surpluses while having no strong effect on output in Japan. RMB appreciation, on the other hand, has an insignificant effect on the current account, although it tends to reduce output in China. For China, dollar pricing with vertical trade integration seems responsible for the insignificant effect on the current account.     

Money,saving and growth in an international economy with perfect capital mobility

The effects of differential national saving rates on current accounts, foreign indebtedness and the welfare of the countries involved are examined within the framework of a two-country, three-asset and one-good model of growth with international capital mobility. It is argued that the persistent current account imbalance and its implied national indebtedness are a natural consequence of differential national saving rates in the world of integrated capital markets, that any direct interference hampering an orderly flow of capital makes both countries worse off, that changes in the exchange rate mainly reflect the differential growth rates of two currencies and have little effect on the current account, and that persistent current account deficits do not necessarily imply an ever-increasing debt burden. While an increase in the saving rate of the high-saving country benefits the low-saving country, an increase in the saving rate of the low-saving country harms the high-saving country both in the short run and the long run.     

Is the Yen/Dollar Exchange Rate Really Responsible for East Asia's Export and Business Cycles? A Commentary on McKinnon and Schnabl (2003)

In a paper published in The World Economy, Ronald McKinnon and Gunther Schnabl claim that fluctuations in the nominal yen/dollar exchange rate are the principal causal factor behind the export and business cycles in East Asian countries ( McKinnon and Schnabl, 2003 ). Their econometric work, however, suffers from at least two important difficulties. First, while McKinnon and Schnabl preclude industry shocks as an explanation for the East Asian countries’ macroeconomic fluctuations, cyclical fluctuations in the global electronics industry have a significant impact on their short‐run export and output dynamics. Second, although McKinnon and Schnabl assume that the relative industrial competitiveness of Japan and other East Asian countries moves in tandem with fluctuations in the nominal yen/dollar exchange rate, the empirical validity of this assumption is not indisputable. Once these two issues are taken into account properly, it becomes very difficult to make a convincing case for the yen/dollar exchange rate being the main driver of East Asia's macroeconomic instability. A brief critique will also be made of another paper that has appeared recently in The World Economy ( Doraisami, 2004 ), which models Malaysia's pre‐crisis export dynamics using the nominal yen/dollar exchange rate as a proxy for the country's export competitiveness.     

Imperfect asset substitutability and monetary policy under fixed exchange rates

This paper presents a long-run model of the open economy in a world of fixed exchange rates and imperfect substitutability between bonds denominated in different currencies. The model explicitly accounts for the wealth flow accompanying current-account imbalance and for the flow of interest payments associated with international lending. Both the dynamic and steady-state implications of the model are quite different from those of models that specify the capital account as a continuing flow responding to the level of interest rates. In particular, we find that when there exists outside government debt, open-market policy is not in general neutral in the long run. We also find conditions under which the central bank is able to hold the domestic price level constant in the face of an inflationary disturbance from abroad without exhausting, in the long run, its stock of domestic assets.     

Synchronised Business Cycles in East Asia and Fluctuations in the Yen/Dollar Exchange Rate

Because many authors have proposed stimulating the ailing Japanese economy by monetary expansion and yen depreciation, we explore the repercussions of depreciating the yen against the dollar on the other East Asian economies – which largely peg to the dollar. Since 1980, economic integration among Japan's neighbours – China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand – has intensified and (except for China and Singapore) their business cycles have been highly synchronised. These cycles have been closely linked to fluctuations in the yen/dollar exchange rate – through changes in the export competitiveness, inflows of foreign direct investment and intra‐Asian income effects. We show that a major yen devaluation would have a negative impact on incomes in other East Asian economies and that it is not a sensible policy option for Japan.     

THE IMPORTANCE OF THE RETENTION RATIO IN A KALECKIAN MODEL WITH DEBT ACCUMULATION

By using a Kaleckian model with debt accumulation, Hein (2007; Metroeconomica, 56 (2), pp. 310–39) found that the long‐run equilibrium value of the debt–capital ratio is positive and stable only if interest rates are extremely high and if the short‐run equilibrium exhibits the ‘debt‐led’ growth regime. However, this conclusion crucially depends on the assumption that the retention ratio of firms is equal to unity. By relaxing this assumption, we show that there exists a positive and stable long‐run equilibrium even under the ‘debt‐burdened’ regime without any constraint on the nominal interest rate.     

Monetary policy in a developing economy with external debt: Theory and empirics

Using annual data from four open economies (Thailand, Indonesia, Mexico, and Chile), and estimating correlations and generalized impulse responses within the traditional vector autoregressive (VAR) analysis, we find that inflation, both in the short and long run, is negatively correlated with consumption, investment, and the stock of foreign debt. We propose an optimizing model of an open economy with outstanding foreign debt and borrowing constraint that could explain these empirics. In this economy, risk premium depends on creditworthiness measured by debt–income ratio. Firms operate under costly investment, and all transactions involving consumption and investment are subject to cash-in-advance (CIA) constraints.     

人民币汇率与FDI关系的实证研究

本文运用协整关系分析和误差修正模型对1979—2008年度人民币双边实际汇率与美国、日本和欧盟对华直接投资的关系进行了实证研究。研究结果表明:对美国而言,从长期来看,人民币对美元升值不仅不会导致中国FDI流入的减少,反而能够促进FDI流入的增加;对日本和欧盟而言,我国国内生产总值的增长率与其对华直接投资之间存在显著的正相关关系;对美、日和欧盟而言,我国的开放度和政策的稳定性对它们的对华直接投资均有显著的正面影响。     

Capital flows to central and Eastern Europe

We examine the evolution of the external position in CEE countries over the past decade, with a strong emphasis on the composition of the international balance sheet. We assess the extent of their international financial integration, in comparison to the advanced economies and other emerging markets, and highlight the most salient features of their external capital structure in terms of the relative importance of FDI, portfolio equity, and external debt. In addition, we briefly describe the bilateral and currency composition of their external liabilities. Finally, we explore the implications of the accumulated stock of external liabilities for future trade and current account balances.     

INTEREST RATE,DEBT, DISTRIBUTION AND CAPITAL ACCUMULATION IN A POST‐KALECKIAN MODEL

In the present paper we extend Lavoie's (Metroeconomica, 1995, vol. 46, pp. 146–177) ‘Minsky–Steindl’ model, building our analysis on a Kaleckian distribution and growth model which has already taken into account distribution effects of interest rate variations on the short‐run equilibrium. Into this model the effects of debt and debt services are explicitly introduced and the effects of interest rate variations on the short‐ and the long‐run equilibrium are derived. It is shown that the effects of interest rate variations on the endogenously determined equilibrium values of the model not only depend on the parameter values in the saving and investment functions but also on the interest elasticity of distribution and on initial conditions with respect to the interest rate and the debt–capital ratio.     

Japan's Negative Risk Premium in Interest Rates: The Liquidity Trap and the Fall in Bank Lending

Japan's interest rates have been compressed toward zero because of pressure coming through the foreign exchanges. Twenty years of current‐account surpluses have led to a huge buildup of claims – mainly dollars – on foreigners. Because of ongoing fluctuations in the yen/dollar exchange rate, Japanese financial institutions will only willingly hold these dollar claims if the nominal yield on them is substantially higher than on yen assets. In the 1990s to 2002 as US interest rates have come down, portfolio equilibrium has been sustained only when nominal interest rates on yen assets have been forced toward zero. One consequence is the now infamous liquidity trap for Japanese monetary policy. A second consequence is the erosion of the normal profit margins of Japan's commercial banks, leading to a slump in new bank credit and an inability to grow out of the overhang of old bad loans.     

Can Japan Make a Comeback?

Since the beginning of the 1990s Japan has experienced economic stagnation. The economy had been allowed to overheat in the 1980s and a bubble had been built up. When this burst, there was massive asset‐deflation, which led to a banking crisis. The bad debts were not faced up to effectively. Japanese banks could not achieve high enough margins to recapitalise themselves, and the government was for a long time reluctant to intervene effectively. The shock made economic agents more pessimistic, which led to an imbalance between savings and investment‐demand. Excess savings were placed abroad and used to finance a domestic fiscal deficit, but this was not enough to close the gap and sustain growth. To be able to run a large current account surplus the yen needed to depreciate, but this was not achieved due to expectations about a future appreciation. The strategy to get out of the liquidity trap would include credible inflation targeting and yen depreciation. Monetary policy should have an inflation target well above zero per cent. Such macroeconomic measures need to be complemented by structural reforms such as deregulation of financial services, competition policy and reallocation of public investments. The Japanese development model with close connections between firms and banks needs to be reformed. Japan should be able to achieve stable growth again, but since the catch‐up phase is over one would not expect growth in Japan to be higher than in other developed countries, even if Japan undertakes the needed reforms.     

Those Current Account Imbalances: A Sceptical View1

The international current account imbalances, where the United States has a vast deficit, and several countries, notably Japan, China, Germany and the oil exporters have corresponding surpluses, are usually seen as problems. The argument here is that current account imbalances simply indicate intertemporal trade – the exchange of goods and services for claims. There are likely to be gains from trade of that kind as from ordinary trade. What, then, are the problems? This paper considers five scenarios, notably one where net savings of the surplus countries decline so that the world real interest rate rises, and another where the US fiscal deficit is reduced, so that the world real interest rate falls and there could be a worldwide aggregate demand problem, essentially caused by the high net savings of the surplus countries. The paper reviews the reasons for the large surpluses in terms of savings and investment ratios (especially China) and also discusses the long‐term problem for the United States. While four of the scenarios involve a decline in the dollar, they do not necessarily imply a sudden – and even ‘disruptive’– dollar crisis.     

Accumulation,Structural Change and External Balances in a World with Internationally Traded Environmental Assets

Environmental literature has largely neglected macroeconomic considerations, especially open economy and asset market ones. This paper develops a small country framework that seeks to address these issues. Medium‐ and long‐run aspects are explored using standard trade and portfolio balance models, modified to incorporate trade in claims on non‐renewable resources (environmental assets). In the medium run, changes in environmental regulations, saving behavior and other variables affect the current account, investment and composition of output. In the long run, both the sectoral intensity of environment use and the structure of the economy are affected, as are the capital stock and the global distribution of claims on resources.     

Debt Relief and the Current Account: An Analysis of the HIPC Initiative

In this paper I develop a model to investigate the connection between debt relief and current account sustainability. This model can be used as a key input in assessing whether a HIPC country's real exchange rate is ‘overvalued,’ and will thus need to go through devaluation. The working of the model is illustrated for the case of Nicaragua, a country that in 2002 had one of the highest external debt to GDP ratios: almost 300 per cent. Nicaragua is the second poorest country in the Western Hemisphere (after Haiti), and for the last decade has relied very heavily on foreign assistance and aid. Moreover, in the last few years Nicaragua has run extremely large current account deficits in excess of 37 per cent of GDP during 1997‐2001 largely financed by grants, donations and migrant remittances.     

Risky business: Financial‐sector liberalization and China

China's dramatic growth in exports, its rising conflict with its trade partners over the perceived undervaluation of the renminbi, and the snail's pace of financial liberalization is pushing its bilateral trade and monetary relations to a boil. Discontent in the United States, Japan, Southeast Asia, and, most recently, Brazil, has led popular pundits and even country finance ministers to speak publicly of a “currency war” with many calling for the de‐pegging of the renminbi to the dollar and an immediate appreciation of China's currency. However, China's history of liberalization, beginning with the opening to the West in 1978, is well known as one of gradualism in trade and the financial spheres. Economic history is replete with economic crises brought on by too rapid or premature liberalization of countries' capital flows. This article presents the case both for and against capital account liberalization and highlights the risks that China in particular confronts in responding to external demands for greater openness and an appreciation of the renminbi. It clearly captures the tightrope that China must walk between responding to the demands of its trade partners and maintaining economic growth and political stability at home. © 2011 Wiley Periodicals, Inc.     

How does capital control spur economic growth?

This paper provides a conceptual and empirical framework for evaluating the effect of capital controls on long‐term economic growth. In a small open economy which relies on successful investment projects to provide capital goods, taking out short‐term loans has two contradictory impacts: (i) it reduces the interest costs of financing investment projects; and (ii) it also leads to larger asset losses in the scenario of short‐term debt run. In this work, we hypothesise that private financing decisions made by domestic investors are distorted towards excessive risk‐taking, leading to ineffective capital formation. Thus, capital control policies, particularly regulations on short‐term loans, can be socially beneficial as they alter the debt composition, promote capital formation and achieve a higher output level. Using a panel data set covering 77 countries from 1995 to 2009, we employ a system generalised method of moments (GMM) estimator to sequentially test three hypotheses and find strong empirical evidence that supports our theory.     

美元周期性波动对我国跨境资本流动的非对称效应研究

有效应对和防范跨境资本流动冲击，维护外汇市场稳定是贯彻落实习总书记“打好防范化解重大风险攻坚战”的重要举措。目前，美元已进入强周期，我国正面临着由强势美元引发的货币贬值、资本外流等风险，当前背景下研究美元周期性波动特征、区制划分及其对跨境资本流动的影响具有重要的理论和现实意义。本文基于2006年10月至2018年6月的月度数据，运用理论模型和MSVAR模型分析美元周期性波动对我国跨境资本流动的非对称效应。研究表明，中美利差对跨境资本流动的影响存在非对称效应，当投资者不存在恐慌避险情绪时，利差的变化将不会引起大规模的跨国资本流动。美元指数对跨境资本流动的冲击效应具有一定的时滞性，美元升值将引发跨境资本流出，且冲击效应持续时间明显长于利差冲击。VIX指数和人民币汇率对跨境资本流动影响较弱，但呈现非对称性特征。加息和缩表后美元升值对资本外流的推动作用明显强于加息和缩表前，表明第三轮强周期下美元升值对我国跨境资本流动的影响更大。     

Information Role of U.S. Futures Trading in a Global Financial Market

Using a bivariate, asymmetric generalized autoregressive conditional heteroskedasticity model, we examine the patterns of information flows for three financial futures contracts that are dual‐listed on U.S. and Asian markets (i.e., Nikkei 225 Index, Eurodollar, and dollar–yen currency futures). The results indicate that the U.S. market plays a leading role in terms of pricing‐information transmission across markets. In terms of volatility spillover across markets, however, foreign markets seem to play a similar role (e.g., Nikkei Index futures) or even a more significant role than the United States (e.g., Eurodollar futures in Singapore and dollar–yen currency futures in Japan). © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1071–1090, 2001