Friday, August 01, 2003
Deflating Spirits-Someone get Japan's finance ministry a copy of a good International Economics book and plunk them down in front of the Purchasing Power Parity page. They’ve spend a record 9 trillion yen (roughly $8 billion) this year trying to drive down the exchange rate. Trying to unilaterally change your currency's price is like the Boy Scout who took and hour-and-a-half helping an old lady across the street-the old lady didn't want to go. Japan's been having to fight off deflation in the last few years. The Bank of Japan has interest rates just above zero, having run smack dab into a classic Keynesian liquidity trap, so they can't use monetary policy to stimulate things. When you have less inflation than your peers, your currency will tend to go up in value. If the US is having 2% inflation and Japan has 1% deflation, you'd expect the yen to go up vis-a-vis the dollar at a 3%/year clip. Market baskets may be different, so such purchasing power parity is a bit slow to kick in, but inflation gets factored into interest rates. PPP's sister, Interest Rate Parity, states that countries with higher interest rates (and thus higher expected inflation) will see their currencies devalue. If Japanese interest rates are 1% less than in the US, expect the yen to go up 1%/year versus the dollar. Financial fat cats will make sure that holds up. If US interest rates are 1% higher, next-years forward exchange rate will be 1% higher to sop up the difference. Yonan's Law of Arbitrage-Free lunches are quickly devoured. An extra $8 billion worth of intervention isn't going to move the market much when the dollar-yen transactions are in the hundreds of billions. However, since they can't play the interest-rate-cut game, they have to do something. They somehow have to goose demand in Japan in order to get some inflationary pressures going. Let's send them our excess Keynesians; no, I don't want to know what "Krugman's steaming pile" translates to in Japanese. If there ever was a spot that ol' John Maynard would fit in, it's modern Japan. Keynesian economics specializes in economies slowed by lack of aggregate demand. However, the problem seems to go beyond fiscal policy. The real question is how to get the Japanese to think positive and start spending more. The more pessimistic you are, the worse the future looks and the more you save for rainy decades. That leads to the deflation and hyper-low interest rates that they have. It seems to be more of a psychological thing than a fiscal thing; tax cuts and/or big government spending hasn't helped. What Japan needs is a Ronald Reagan, for modern Japan has a bit of the feel of the late-70s US, a bit rudderless and unsure of where it's heading. I don't see him or her on the horizon, but let's keep looking.
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