Wednesday, November 30, 2011

Japanese Bond Yields Not As Low As They Appear

Kash Mansori notes that despite the fact that both the deficit and the debt level in Japan are higher, bond yields are far higher in Italy, 7% (not 8% as he asserted) in Italy versus 1% in Japan.

The explanations that he offers, (the Japanese access to a printing press, high domestic savings and the vicious cycle created by the self-fulfilling prophecy of default) for this are basically correct and correspond largely to my explanation of the low U.S. bond yields (except that in the U.S., foreign central banks fill the role of domestic savers in Japan).

However, it should be noted that Japanese bond yields aren't as low as they seem. Japan has for the last two decades or so had more or less persistent price deflation even as the rest of the world has had almost persistent price inflation. This means that real interest rates are much higher in Japan compared to the rest of the world then what nominal interest rates would suggest.

In the year to October this year, consumer price inflation was 3% in the euro area and -0.2% in Japan . That means that the nominal difference in interest rate of about 6% was in real terms less than half of that.

The point here is not to deny that Italian bond yields are disturbingly high as they certainly are. The point is instead that even professional economists and bond investors (who really should know better) seems to fall for the money illusion as they compare without further thought bond yields in different currency areas without any regard for inflation.


Blogger doug said...

Excellent point. Seems to me that at some point, the BOJ will have to print to buy all that debt when their economy spirals down because of the unfavorable (high) exchange rate. In fact, it seems to me that the reason Japan has suffered deflation and we are going to suffer inflation, is that they floated debt to the public while we floated debt to the fed (printed).

9:03 PM  
Blogger Ralph Musgrave said...

The money illusion is not the only illusion that economists call for. There is also expansionary austerity, the confidence fairy, Ricardianism: the list seems to be long. Or in the words of Dean Baker, “If we ask why economists would believe something about the world that seems to fly in the face of evidence, my answer would be that it is the easiest path for them….”. See:

12:48 PM  

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