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Courtesy of Paul Krugman
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THE CONSCIENCE OF A LIBERAL
Paul Krugman
NYT
The Yen And The Low-Inflation Trap
I’m in Japan for a conference tomorrow. Here’s how I expect it to go:
I’ve already had one very jet-lagged meeting, in which I was asked for thoughts on the strong yen, which is making Japanese manufacturers very unhappy. Here are some thoughts.
The key thing, I believe, is that real interest rates in the United States and other advanced countries are now significantly lower than in Japan. If you look at the Treasury real yields, the interest rate on US 5-years indexed to inflation is now around -.5, that’s right, minus 0.5. In Japan the nominal rateis lower, but not zero even though markets are signaling that they expect continued deflation over the next 5 years.
As I’ve tried to explain, that’s because of the option value: short-term rates can go up but they can’t go down. And the result is that Japan has a significantly positive real 5-year rate, around 0.7 percent.
So Japan, having allowed deflation to get embedded in expectations, ends up being just what it doesn’t want to be: a magnet for capital fleeing low yields in the US and elsewhere.
That said, I would argue that the United States is already on the edge of itsown low-inflation trap. Japan is us, a few years from now, but with less misery.
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