Download International Creditors under the World Dollar Standard

International Creditors under
the World Dollar Standard:
Japan’s Liquidity Trap Redux
Ronald I. McKinnon (Stanford)
Rishi Goyal (IMF)
Thesis: Conflicted Virtue
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Creditor economies with:
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history of current account surpluses and
build up of liquid foreign currency claims
could face deflation and a liquidity trap
Obvious example: Japan
However, China and other East Asian
creditors may follow
Thesis described (1)
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The world is on a dollar standard
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creditor economies build up claims on rest of the
world in dollars
Exchange rate fluctuation (or anticipated
appreciation)
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domestic currency value of dollar holdings
fluctuates or may fall
risky to hold dollar assets
dollar assets must pay premium
domestic interest rates lower than U.S. rates
Thesis described (2)
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Risk premium could be large
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e.g. Japan: where financial institutions
intermediating the claims have net worth
close to the regulatory minimum
Continued build up of dollar claims
domestic interest rates could decline to low
levels
 economy could fall into liquidity trap
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Thesis described (3)
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In liquidity trap:
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monetary policy: ineffective to halt deflation
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bank credit to private credit slumps:
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profit margins on lending low/negative;
so, investment weakens;
banks unable to recapitalize themselves; may need successive
bailouts
portfolio reallocation: private sector sells foreign currency
assets and purchases domestic currency assets
central bank purchases foreign currency assets
 large buildup in foreign currency reserves
Investment is weak at low interest rates
i
Supply of loans, Ls
Demand for loans, Ld
Ld '
i
Ls , Ld
Note: Supply of loans is limited below i.
Model (1)
Modification of Mundell-Fleming
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Asset market equilibrium:
i = i* + Dse + j (S NfxA/A; ss)
Money market equilibrium:
Ms/P = L(i, Y)
(perfectly elastic at low interest rates)
Model (2)
Goods market equilibrium:
Y = C(Y–T, i–pe–ra)+I(i,pe)+G+NX(q,Y–T)
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Real exchange rate and inflation:
q = S P*/P
pe = Dse + p*e – Dqe(Y – Yf )
Foreign asset accumulation:
Ft+1 = (1+i*) Ft + NXt (Pt/St)
Rest of the paper
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Analysis of the model
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Application to:
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outside and inside the liquidity trap
sterilized and unsterilized interventions
changes in the world real interest rate
Japan, China, other East Asian creditors
ongoing U.S. current account deficits
Policy conclusions