International creditors under the world dollar standard japan s liquidity trap redux
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International Creditors under the World Dollar Standard: Japan’s Liquidity Trap Redux. Ronald I. McKinnon (Stanford) Rishi Goyal (IMF). Thesis: Conflicted Virtue. Creditor economies with: history of current account surpluses and build up of liquid foreign currency claims

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International Creditors under the World Dollar Standard: Japan’s Liquidity Trap Redux

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International creditors under the world dollar standard japan s liquidity trap redux

International Creditors under the World Dollar Standard:Japan’s Liquidity Trap Redux

Ronald I. McKinnon (Stanford)

Rishi Goyal (IMF)


Thesis conflicted virtue

Thesis: Conflicted Virtue

  • Creditor economies with:

    • 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

Thesis described (1)

  • The world is on a dollar standard

    • creditor economies build up claims on rest of the world in dollars

  • Exchange rate fluctuation (or anticipated appreciation)

    • 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

Thesis described (2)

  • Risk premium could be large

    • 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


Thesis described 3

Thesis described (3)

  • In liquidity trap:

    • monetary policy: ineffective to halt deflation

    • bank credit to private credit slumps:

      • 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


International creditors under the world dollar standard japan s liquidity trap redux

Investment is weak at low interest rates


Model 1

Model (1)

Modification of Mundell-Fleming

  • 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

Model (2)

  • Goods market equilibrium:

    Y = C(Y–T, i–pe–ra)+I(i,pe)+G+NX(q,Y–T)

  • 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

Rest of the paper

  • Analysis of the model

    • outside and inside the liquidity trap

    • sterilized and unsterilized interventions

    • changes in the world real interest rate

  • Application to:

    • Japan, China, other East Asian creditors

    • ongoing U.S. current account deficits

  • Policy conclusions


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