Japan's Negative Risk Premium in Interest Rates: The Liquidity Trap and Fall in Bank Lending

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Japan's Negative Risk Premium in Interest Rates: The Liquidity Trap and Fall in Bank Lending

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Rishi Goyal
Ronald McKinnon

Abstract

May 2002

Japan's interest rates have been compressed toward zero because of pressure coming through the foreign exchanges. Twenty years of current account surpluses have led to a huge build up of claims – mainly dollars – on foreigners. Because of ongoing fluctuations in the yen/dollar exchange rate, Japanese financial institutions will only willingly hold these dollar claims if the nominal yield on them is substantially higher than on yen assets. In the 1990s to 2002 as U.S. interest rates have come down, portfolio equilibrium has been sustained only when nominal interest rates on yen assets have been forced toward zero. One consequence is the now infamous liquidity trap for Japanese monetary policy. A second consequence is the erosion of the normal profit margins of Japan's commercial bank leading to a slump in new bank credit and an inability to grow out of the overhang of old bad loans.

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Paper provided by Stanford University, Department of Economics in its series Working Papers with number 02006.

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Date of creation: May 2002
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Handle: RePEc:wop:stanec:02006

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Ronald McKinnon & Kenichi Ohno, 2001. "The Foreign Exchange Origins of Japan's Economic Slump and Low Interest Liquidity Trap," The World Economy, Blackwell Publishing, vol. 24(3), pages 279-315, 03. [Downloadable!] (restricted)
Shirakawa, Masaaki, 2001. "Monetary Policy Under the Zero Interest Rate Constraint and Balance Sheet Adjustment," International Finance, Blackwell Publishing, vol. 4(3), pages 463-89, Winter. [Downloadable!] (restricted)
Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1998-2), pages 137-206. [Downloadable!]
Gian Maria Milesi-Ferretti & Philip R. Lane, 2001. "Long-Term Capital Movements," IMF Working Papers 01/107, International Monetary Fund. [Downloadable!]
Other versions:
- Philip Lane & Gian Maria Milesi-Ferretti, 2001. "Long-Term Capital Movements," CEG Working Papers 20018, Trinity College Dublin, Department of Economics. [Downloadable!]
- Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2001. "Long-Term Capital Movements," CEPR Discussion Papers 2873, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
- Philip R. Lane & Gian Milesi-Ferretti, 2001. "Long-Term Capital Movements," NBER Working Papers 8366, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Philip Lane & Gian Maria Milesi-Ferretti, 2001. "Long-Term Capital Movements," Trinity Economics Papers 200112, Trinity College Dublin, Department of Economics. [Downloadable!]
- Philip R. Lane & Gian Maria Milesi-Ferretti, 2002. "Long-Term Capital Movements," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 73-136 National Bureau of Economic Research, Inc. [Downloadable!]
Svensson, Lars E O, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," CEPR Discussion Papers 2566, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
Other versions:
- Svensson, Lars, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Seminar Papers 687, Stockholm University, Institute for International Economic Studies. [Downloadable!]
- Lars E.O. Svensson, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," NBER Working Papers 7957, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Svensson, Lars-E-O, 2001. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 277-312, February. [Downloadable!]
Yoshikawa, Hiroshi, 1990. "On the Equilibrium Yen-Dollar Rate," American Economic Review, American Economic Association, vol. 80(3), pages 576-83, June. [Downloadable!] (restricted)

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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers 03001, Stanford University, Department of Economics. [Downloadable!]
Other versions:
- Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers 112003, Hong Kong Institute for Monetary Research. [Downloadable!]
- Ronald McKinnon & Gunther Schnabl, 2004. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Review of Development Economics, Blackwell Publishing, vol. 8(3), pages 331-360, 08. [Downloadable!] (restricted)

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