Comments on Defying Gravity: How Long Will Japanese Government Bond Prices Remain High? by Takeo Hoshi and Takatoshi Ito

Transcription

1 Commens on Defying Graviy: How Long Will Japanese Governmen Bond Prices Remain High? by Takeo Hoshi and Takaoshi Io Bob Hodrick Nomura Professor of Inernaional Finance Columbia Business School April il4, 2012

2 Summary Japan s Deb o GDP raio is he highes in he world, governmen budge deficis are large, ye ineres raes on JGBs remain low. This siuaion is suppored by home biased domesic savings, a sagnan economy wih low expeced raes of reurn, and expecaions of fuure fiscal consolidaion. Bu, a fiscal crisis is looming when deb his he ceiling on privae secor asses. The sock of governmen bonds is hough o exceed he abiliy of he privae secor o by he bonds. Financial markes appear o be unaware of his problem, bu if hey should realize is possibiliy, he crisis would sar sooner. Fiscal consolidaion now can avoid he problem.

3 Japan's Deb o GDP Raio Ne Deb 100 Gross Deb

4 Ne Governmen Deb o GDP Raios France Germany Greece Ireland Ialy Porugal Spain

5 5 and 10 yr JGB Yields and 5 yr CDS yr JGB 1 5 yr JGB 5 yr CDS 0.5 0

6 Bu, Japan s CDS rae is he 4 h lowes of any counry. 5 yr CDS in % p.a. US 0.31 UK 0.64 Germany 0.75 Japan 1.04 France 1.75 Belgium 2.30 Ialy Spain 4.30

7 B T The Governmen s Budge Consrain nominal deb, G nominal governmen spending, nominal axes, i nominal ineres rae B B G i B T he budge defici 1 Divide id by Y nominal GDP. Y B 1 Y 1 B G B T i Y Y Y Y Y Y 1 b (1 ) b g ib he growh rae of nominal GDP

8 The Governmen's Primary Surplus o GDP raio = g b (1 ) (1 i ) b ( g ) 1 1 The Deb o GDP raio sabilizes, b 1 b, when g ( i 1 ) b The Deb o GDP raio grows when ( ) ( ) g i 1 b

9 4 Primary Surplus o GDP Raio

10 Wih one period deb, unanicipaed inflaion helps only in he firs period. Wih muli period deb, changing he rae of inflaion can reduce he deb o GDP raio because ineres is fixed for awhile. Alernaive scenarios: i 1% b 1.53%), 1 ( 0.02,0.035 g 6% ( b 1.53%), 0.10,0.20

11 Fuure Pahs of Deb o GDP Raio % % % 2%, 20% % 3.5%, 20% 2%, 10% % 00% 3.5%, 10% % % %

12 Limis on Deb Hoshi and Io argue ha because 95% of JGBs are currenly held by he Japanese public, any fuure increases in db deb mus also be held by he Japanese public. I disagree. From Naional Income Accouning Y C I G CA P S Y i B T C P P S C I G CA i B T C ( S I ) ( T i B G ) CA

13 6 The Curren Accoun as a % of GDP

14 Implicaions of Curren Accoun Surpluses In spie of he governmen s primary deficis, Japan runs curren accoun surpluses ha average 2.9% of GDP. Curren accoun surpluses imply he acquisiion of Ne Foreign Asses. Japan currenly has Ne Foreign Asses equal o 60.5% of GDP. Thus, Japan can run curren accoun deficis equal o 3% of GDP for20years bf before any foreigner has obuy a JGB! Hoshi and Io conclude oherwise because hey look a a very Hoshi and Io conclude oherwise because hey look a a very narrow definiion of financial wealh. They exclude he value of equiies.

15 On Ricardian Equivalence Budge deficis imply py fuure axes o pay pyhe ineres on he deb. If he privae secor is sufficienly raional and inerconneced hrough generaional bequess, he ime pah of governmen axaion does no maer excep as i creaes disorions of incenives. Japanese consumer/savers appear o be quie Ricardian. In he face of massive budge deficis, hey save enough o have a curren accoun surplus.

16 Conclusions Boh Japan and he U.S. face issues of fiscal consolidaion. Financial markes currenly hink ha his will happen. They rus he poliicians o compromise and avoid a crisis. Ofen, crises arise when foreigners refuse o fund he governmen. The magniude of Japan s Ne Foreign Asses implies ha such a day is quie far in he fuure. Since mos of hese asses are no yen denominaed, a modes depreciaion of he yen implies an increase in wealh. A depreciaion also increases Japanese compeiiveness. Fiscal consolidaion now would cerainly be good, bu a crisis in 2020 seems a very remoe possibiliy. I hink he bond vigilanes have go i righinbohcounries.