Deciphering Japan’s “Safe Haven” Status

In the Dec. 30 issue of The Financial Times, the journalist Alice Ross notes the strength of the yen against the euro, which she attributes to the yen’s “enduring status as a haven against the global financial turmoil.”

“The single currency fell as much as 0.7 per cent against the yen to trade as low as 99.97 on the last trading day of the year, the first time it had fallen below the 100 mark since June 2001,” she writes.

Well, yes — Japan is seen as safe, despite its high level of debt, just like all the other advanced

countries that have retained their own currencies.

But there’s a special feature of Japan that is important in understanding the high yen: the interaction between deflation and the zero lower bound.

Japan, of course, has deeply embedded deflation, while both the euro area and the United States still have modest positive expected inflation. Expectations of deflation tend to push interest rates down. But short rates can’t go below zero. And the Japanese long rate has to stay some ways above zero, because it in effect contains an option value: short rates can go up, but they can’t go down.

So Japan has expected inflation that is around 2 points less than in other safe haven countries, but it has long interest rates that are only about 1 percentage point lower; Japan is a high real rate country. And this pushes up the value of the yen.

Just to be clear, this is a bad thing from Japan’s point of view; the country really needs more exports, and the high yen prevents that.

Another reason why you really, really don’t want to get into a deflation trap.

Olivier Blanchard at the I.M.F. Is Not Very Serious

And when you bear in mind that the Very Serious People have been wrong about everything, that’s a very good thing.

What’s even better is that as the chief economist at the International Monetary Fund, Mr. Blanchard is helping to make at least one international institution less austerity-mad than the others.

His recent blog post on the I.M.F.’s Web site on what went wrong in 2011 is, in fact, totally sensible and on point. Furthermore, if I am reading it right, it contains something of a bombshell: “Financial investors are schizophrenic about fiscal consolidation and growth,” he wrote on Dec. 21. “They react positively to news of fiscal consolidation, but then react negatively later, when consolidation leads to lower growth — which it often does. Some preliminary estimates that the I.M.F. is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds. To the extent that governments feel they have to respond to markets, they may be induced to consolidate too fast, even from the narrow point of view of debt sustainability.” (My emphasis.)

If I have this right, Mr. Blanchard is suggesting that harsh austerity programs may be literally self-defeating, hurting the economy so much that they worsen fiscal prospects. This in turn means that the analogy to medieval doctors who bled their patients, then bled them even more when the bleeding made them sicker, is exactly right: austerity reduces growth prospects, leading to calls for even more austerity.


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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.

Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including “The Return of Depression Economics” (2008) and “The Conscience of a Liberal” (2007).

Copyright 2011 The New York Times.