1. International Creditors under the World Dollar Standard: Japan’s Liquidity Trap Redux Ronald I. McKinnon (Stanford) Rishi Goyal (IMF)

2. Thesis: Conflicted Virtue Creditor economies with: history of current account surpluses and build up of liquid foreign currency claims could face deflation and a liquidity trap Obvious example: Japan However, China and other East Asian creditors may follow

3. Thesis described (1) The world is on a dollar standard  creditor economies build up claims on rest of the world in dollars Exchange rate fluctuation (or anticipated appreciation)  domestic currency value of dollar holdings fluctuates or may fall  risky to hold dollar assets  dollar assets must pay premium  domestic interest rates lower than U.S. rates

4. Thesis described (2) Risk premium could be large e.g. Japan: where financial institutions intermediating the claims have net worth close to the regulatory minimum Continued build up of dollar claims  domestic interest rates could decline to low levels  economy could fall into liquidity trap

5. Thesis described (3) In liquidity trap: monetary policy: ineffective to halt deflation bank credit to private credit slumps: profit margins on lending low/negative; so, investment weakens; banks unable to recapitalize themselves; may need successive bailouts portfolio reallocation: private sector sells foreign currency assets and purchases domestic currency assets central bank purchases foreign currency assets  large buildup in foreign currency reserves

6. Investment is weak at low interest rates

7. Model (1) Modification of Mundell-Fleming Asset market equilibrium: i = i* +  s e +  (S NfxA/A;  s ) Money market equilibrium: M s /P = L(i, Y) (perfectly elastic at low interest rates)

8. Model (2) Goods market equilibrium: Y = C(Y–T, i–  e –r a )+I(i,  e )+G+NX(q,Y–T) Real exchange rate and inflation: q = S P*/P  e =  s e +  *e –  q e (Y – Y f ) Foreign asset accumulation: F t+1 = (1+i*) F t + NX t (P t /S t )

9. Rest of the paper Analysis of the model outside and inside the liquidity trap sterilized and unsterilized interventions changes in the world real interest rate Application to: Japan, China, other East Asian creditors ongoing U.S. current account deficits Policy conclusions