What The Strong Euro Is Telling Us
Summary
- It's become a cliché that the Japanese yen is a "safe haven currency", which does well when things are going poorly in the global economy.
- I've never really understood that claim. What makes Japan a safe haven? And why does the yen do well even when Japan itself is the epicenter of the problem, as with the 2011 tsunami?
- In the past, I've offered an alternative theory, that Japan's yen appreciated during times of trouble because Japan was at the zero bound.
It's become a cliché that the Japanese yen is a "safe haven currency", which does well when things are going poorly in the global economy. I've never really understood that claim. What makes Japan a safe haven? And why does the yen do well even when Japan itself is the epicenter of the problem, as with the 2011 tsunami? People have offered explanations, but they seem quite weak, very ad hoc.
In the past, I've offered an alternative theory, that Japan's yen appreciated during times of trouble because Japan was at the zero bound. Because the BOJ could not cut rates further, a fall in global interest rates tends to raise Japan's policy rate relative to the equilibrium interest rate. This makes Japanese monetary policy tighter. In contrast, the Fed tends to cut interest rates when the equilibrium interest rate falls (albeit with a lag.) My theory also explains why the rise in interest rates after Trump's election had the effect of helping Japan, making their monetary policy a bit looser.
How would we test my theory? Suppose another big economy also hit the zero bound, an economy that could not possibly be regarded as a safe haven. Also assume that the currency in that economy appreciated strongly during a global crisis, even though the epicenter of the crisis was in that very economy.
Of course, I'm talking about the eurozone, which is currently at the center of the global coronavirus problem. The euro is appreciating strongly:
PS. My previous post may have created the impression that I thought monetary policy in the US was currently appropriate. Just the opposite is true; policy is far too contractionary. Right now, I don't think it's useful to give monetary policy advice in terms of interest rates, as the equilibrium interest rate is so unstable. So here's what I'd recommend:
1. The Fed should ask Congress for the ability to buy a wide range of assets during an emergency.
2. The Fed should eliminate IOR and buy enough assets to push 12-month inflation/NGDP growth expectations up to the policy target.
NO MATTER HOW MUCH IT TAKES.
But then that's always been my view.
PPS. File this under "Karma’s a bitch".
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