Scott Sumner  

Safe haven or tight money?

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My previous post on the Japanese safe haven question elicited a variety of interesting comments. Further research suggests that Japanese stocks do indeed tend to fall when the yen strengthens for "safe haven" reasons. That's certainly an odd reaction.

I think there's a much better explanation for the response of Japanese asset prices to global shocks---monetary policy. Suppose that a bearish global shock reduces the equilibrium global real interest rate. Also suppose that Japan fails to respond to this change by reducing their monetary policy target interest rate, and also refuses to take other monetary steps such as depreciating the yen. In that case, the target interest rate would rise relative to the (now falling) natural rate of interest. This means that monetary policy would become more contractionary. This is true even if (as is more likely) the BOJ does take some offsetting steps, but these actions are not sufficient to fully offset the bearish global shock.

A contractionary monetary shock would be expected to do the following:

1. Appreciate the yen.
2. Reduce Japanese equity prices.

And that is exactly what happens. In contrast, the "safe haven" theory seems unable to explain all sorts of facts, such as:

1. Why is Japan a safe haven, and not some other country?
2. Why do Japanese stocks fall sharply when capital flows into the Japanese "safe haven"?

PS. A number of commenters including Rajat, Julius Probst, and Benoit Essiambre offered similar explanations.

PPS. If you think it "natural" that Japanese stocks would fall when the yen strengthens for "safe haven" reasons, then you are incorrectly reasoning from a price change. When a bullish factor for equities causes a currency to strengthen as a side effect, that currency appreciation will not prevent stocks from rising in value, as we saw in the US during 1995-2000.




COMMENTS (4 to date)
Jared writes:

Given your use of the natural interest rate, do you mean the interest rate from the loanable funds model? How do you reconcile the loanable funds model and the liquidity preference model? If you have written on this, please provide a link. Nick Rowe has a post on this from a few years ago: http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/04/teaching-loanable-funds-vs-liquidity-preference.html. Thanks

Keenan writes:

Scott, this is off-topic, but do you have any thoughts on the holdings of the Swiss Central Bank? Namely, that they hold a lot of US stocks. What is the rationale for this and is this something the Fed might ever conceivably do? Thanks!

Scott Sumner writes:

Jared, The natural interest rate can be defined as one that leads to macroeconomic equilibrium--say on target inflation.

Those two models seem hard to reconcile--I presume any explanation needs to explain how monetary policy affects the loanable funds market.

Keenan, I've done some posts on that. The problem is Switzerland's low inflation rate, which creates a huge demand for Swiss base money, forcing the SNB to buy lots of assets.

Marcus Nunes writes:

Long view on Japan - FX, Nikkei (and NGDP)
https://thefaintofheart.wordpress.com/2012/07/08/japan-poster-child-for-ngdp-targeting/

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