Morning Must-Read: Paul Krugman: Shinzo and the Invisibles
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Shinzo and the Invisibles:
“Brad DeLong is puzzled by… Ken Rogoff[‘s]…
…warning that Japan could face an attack from invisible bond vigilantes if it doesn’t quickly tackle long-run fiscal issues. I’m puzzled too… The truth is that I said such things about the US back in 2003. But I was wrong…. Rudi Dornbusch’s ‘overshooting’ model…. Invisible bond vigilantes. Suppose… they suddenly demand that Japanese 10-year bonds offer a rate of return 200 basis points higher than US 10-year bonds. You might be tempted to say that Japanese interest rates will spike–but the Bank of Japan controls short-term rates, and long-term rates are mainly an average of expected short-term rates, so how is this supposed to happen?… Instead, the yen would depreciate now so that investors can expect it to appreciate later. And this yen depreciation would be expansionary…. The invisible vigilantes would be doing Japan a favor if they suddenly materialized and attacked!
I’ve had many discussions with smart people about this, and have never gotten an explanation of why it’s wrong; we usually end up with something like a warning that Japanese deflation might suddenly turn into uncontrolled inflation, which seems unlikely and certainly isn’t the way the warnings are usually phrased–we’re supposed to worry about turning into Greece 2010, not Weimar 1923. You might think that what we’re talking about is the lessons of history–but as far as I can tell, there are no historical examples of countries with debts in their own currency facing a Greek-style crisis…