Tuesday, July 19, 2011

Why Low Japanese Bond Yields?

Paul Krugman asks why Japan has so much lower bond yields than Italy, even though both its deficit and its debt level is in fact a lot higher.

First of all, it should be noted that interest rates really aren't as low in Japan as they might appear at first glance. Japan has, and has had for many years, an inflation rate two to three percentage points lower than in the euro area, so its bond yields of slightly above 1% is actually the equivalent of slightly more than 3 to 4%.

However, even after that adjustment, Japan still has lower interest rates. Some people argues that it is the fact that Japan has a current account surplus, while Italy has a deficit, combined with the existence of a "home bias" among investors, that explains it.

That is probably one partial explanation, as many Japanese savers have indeed a strong "home bias", in part due to aversion to exchange rate risks, in part due to xenophobia.

Another explanation is that there is currently a self-fulfilling prophecy (aggravated by the recent ill-advised ECB interest rate increase) in markets about the risks of certain European governments. Until recently, when differences in deficits and debts were more or less the same, the difference in inflation adjusted yields were very low.


Blogger Jim Slip said...

It isn't then because Japan issues a free-floating currency, and it's central bank sets and controls rates according to it's monetary policy via short-term policy moves, in what is (bond issuance) essentially a bank-reserves drain?

It isn't in fact the same for the US and the UK, and any other country that issues it's own free-floating currency?

Isn't actually the difference with the Eurozone the fact that the Eurozone countries are currency users and not currency issuers?



You should really embrace Modern Monetary Theory (MMT), Stefan.

4:33 AM  

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