Non Technical Summary

Japan's Exorbitant Privilege

Author Name Kenneth S. ROGOFF (Harvard University) / TASHIRO Takeshi (Consulting Fellow, RIETI)
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This Non Technical Summary does not constitute part of the above-captioned Discussion Paper but has been prepared for the purpose of providing a bold outline of the paper, based on findings from the analysis for the paper and focusing primarily on their implications for policy. For details of the analysis, read the captioned Discussion Paper. Views expressed in this Non Technical Summary are solely those of the individual author(s), and do not necessarily represent the views of the Research Institute of Economy, Trade and Industry (RIETI).

The concept of "exorbitant privilege" has received great attention from policy makers as well as academics worldwide. The idea originally referred to the willingness of foreigners to hold large quantities of US government debt at extremely low interest rates, due to the dollar's world reserve currency status. In recent years, the term exorbitant privilege has been expanded to explain why the US appears to be enjoying excess return from its external assets over liabilities across all asset classes, including foreign direct investment, equities and other forms of portfolio investment. In this paper, we give a brief review of the recent literature on exorbitant privilege, and then proceed to discuss exorbitant privilege in the context of another country, Japan, which has been the world's largest creditor nation for more than two decades.

Contrary to conventional wisdom, we find that Japan's overall performance in international investing has not been nearly as catastrophic as it is sometimes portrayed. Indeed, in recent years, Japan has been enjoying positive exorbitant privilege, from the narrow definition to the broad definition. The evidence might be interpreted as suggesting that Japan has achieved safe-haven status, particularly against extreme events as suggested, for example, by Farhi and Gabaix (2013). However, it is notable that Japan's debt liabilities are of considerably shorter duration than its debt assets, implying the country's overall foreign portfolio is subject to maturity transformation risks. Moreover, the short-term portfolio external debt is overwhelmingly government debt and the long-term portfolio external assets are mainly private. In addition, the government itself holds huge amount of long-term external assets through its reserves. Whether Japan continues to enjoy its exorbitant privilege in future decades depends, of course, on successfully navigating such risks.

Table 1: Estimates of Return Differentials, 1996-2013
Assets Liabilities Difference
Total Total 4.2 3.1 1.1
Yield 3.6 1.9 1.7
Stock-flow adjustment effects 0.6 1.3 -0.6
FDI Total 4.3 9.1 -4.8
Yield 6.4 8.3 -1.9
Stock-flow adjustment effects -2.0 0.9 -2.9
Debt Total 5.8 0.4 5.5
Yield 5.2 2.5 2.6
Stock-flow adjustment effects 0.7 -2.1 2.8
Equity Total 10.9 8.8 2.1
Yield 5.2 1.3 3.9
Stock-flow adjustment effects 5.7 7.5 -1.8
Others Total 2.2 3.4 -1.2
Yield 1.9 1.6 0.4
Stock-flow adjustment effects 0.3 1.9 -1.5
Reserves Stock-flow adjustment effects 1.8
(for reference)
Debt and reserves
Yield 1.2
Note: Stock-flow adjustment is "change in outstanding" minus "financial account."
Income flow from reserves is not available separately. We show yield from aggregate of debt and reserves for the source of debt income flow as a reference.
Reinvested earning for FDI is included for this return differentials estimation.
Assets and liabilities outstanding include securities lending in 1995 used as denominators for computing return differentials for 1996 because of data availability.
Sources: Asset and liabilities outstanding: Bank of Japan/Ministry of Finance, International Investment Position . Balance on income and financial account: Bank of Japan/Ministry of Finance, Balance of Payments statistics , and IMF, Balance of Payments statistics. Inflation: IMF, International Financial Statistics.