Does exorbitant privilege separate dollar from yen?


Mitsuo Shiota


April 27, 2021

I sometimes feel uneasy about the guest essays named “Lecture on Economics” in Nikkei news paper. The theme is the same as the previous one, “Policy proposal for post-Covid-19”. The guest is Shumpei Takemori, an economics professor and a member of Council on Economic and Fiscal Policy, on April 27, 2021.

I first felt uneasy about his proposal, “Watch out deterioration in net international investment position, if fiscal stimulus is excessive in Japan.” Should we worry about international investment position, when its net asset is 65 percent of GDP at the end of 2019, and current account balance has been continuously positive since 1981? But, if fiscal stimulus is unimaginably huge, interest rates can go up, the yen can appreciate, and current account balance can be negative.

Let us think in the framework of “Swan Diagram”, in which x axis is domestic absorption and y axis is real exchange rate (up is appreciation). Internal balance line is a upward slope, of which the left is unemployment and the right is inflation. External balance line is a downward slope, of which the left is current account surplus and the right is current account deficit. Cross point is both internally and externally balanced. Imagine unimaginably huge fiscal stimulus increases domestic absorption, and moves the point to the right of both lines. In the “Mundell–Fleming model”, as the yen is under the flexible exchange rate regime and stimulus comes from fiscal policy, the interest rates go up and the yen appreciates, so the point moves along the internal balance line. This means no inflation, but current account deficit. In the real world, in which nominal and real exchange rates fluctuate frequently, the point is sometimes on the internal balance line, but mostly in the region of the right of both lines. This means both inflation and current account deficit.

So, unimaginably huge fiscal stimulus can cause deterioration in net international investment position eventually in Japan. But is it a problem to watch out?

He continues, “If fiscal stimulus is excessive in the U.S., only inflation can be a problem. As the dollar is widely used in the international transactions, investors’ confidence in the dollar solely depend on inflation.”

If he implies that the U.S. can continue to be in current account deficits, as the dollar has exorbitant privileges, he is wrong. There are many other countries, like New Zealand and Australia (up to 2018), with continuous current account deficits. I am not saying the dollar’s exorbitant privileges don’t exist. As the dollar has exorbitant privileges, the U.S. banks can dominate international transaction clearing, the U.S. government can impose economic sanctions on foreigners, and the U.S. can benefit from zero interest rate finance by floating greenbacks abroad. But the U.S. continuous current account deficits is not due to the dollar’s exorbitant privileges.

If he implies that the yen will lose investors’ confidence once Japan falls into current account deficits, he suggests currency crisis can be the problem in Japan. Currency crisis starts from accumulated foreign currency denominated short-term debt. And it will take some time to accumulate. In the mean while, the yen depreciates, the current account balance increases, and debt stops to accumulate. Although the yen does not have exorbitant privileges, it is unlikely that Japan falls into currency crisis because of fiscal stimulus, however huge it is.

After all, I don’t understand why he proposes that we should watch out current account balance when we consider fiscal stimulus in Japan. I feel uneasy at his saying about current account balance deterioration without mentioning interest and exchange rates.