Down Goes the Yen

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Many argue that Japan’s attempts to support the yen are being thwarted by its own central bank. A major reason for the yen’s depreciation is that the Bank of Japan has maintained ultra-low interest rates

Takatoshi Ito

TOKYO – On September 22, Japan’s government purchased yen on the foreign-exchange market for the first time since 1998. The finance ministry was attempting to stem the yen’s rapid slide, and for a while, the $20 billion intervention seemed to be working: the yen’s value rose from nearly ¥146 per US dollar to slightly less than ¥141. But not long after the intervention ended, the yen began to backslide. The dollar-yen rate remained below ¥146, the intervention point, for almost three weeks, before falling to almost ¥150 on October 19.

One might wonder whether this is such a bad thing. A weak currency, however, is supposed to benefit exporters – and thus boost economic growth.

The problem is that Japanese manufacturing firms have increasingly shifted their production facilities abroad in recent decades. While yen depreciation swells the profits and dividends of foreign subsidiaries, it does not boost export volumes or domestic employment, at least not immediately.

Imported inflation

Not only does yen depreciation bring few benefits; it also carries high costs, in the form of imported inflation. Japan’s consumer inflation rate hit 3% in August. Though this might seem modest compared to inflation elsewhere – in the United States, for example, the consumer price index rose by 8.2% in September – it is the country’s highest rate since 1991.

This has put serious pressure on Japanese Prime Minister Fumio Kishida’s government, which has made fighting inflation and mitigating its impact a top priority. Attempting to limit yen depreciation – which the public partly blames for price increases – was a natural step in this process.

To be sure, interventions in foreign-exchange markets are usually politically fraught, and the consensus among G7 countries is that exchange-rate movements should be determined by market forces. But the G7 also agrees that excessive volatility is undesirable. And the yen’s exchange-rate movements – namely, a depreciation of more than 25% against the US dollar this year – seem to satisfy that condition. On September 22 alone, the yen depreciated by ¥2 per dollar before close of business, when the intervention was launched. As the exchange rate’s deviation from the long-run trend grows, so does the incentive to intervene.

Ultra-low interest rates

Yet many argue that Japan’s attempts to support the yen are being thwarted by its own central bank. A major reason for the yen’s depreciation is that the Bank of Japan has maintained ultra-low interest rates – the policy rate stands at -0.1%, and the ceiling on the ten-year-bond rate is 0.25% – even as other major central banks hike rates. Portfolio capital has thus been flowing out of Japan toward economies like the US.

The BOJ remains committed to this approach. On the day of the foreign-exchange intervention – a day after the US Federal Reserve raised its policy rate by 75 basis points – BOJ Governor Haruhiko Kuroda announced that the central bank would “not raise rates for the foreseeable future.” The Japanese economy is still in recovery mode, Kuroda argues, and the “high” inflation rate of 3% is temporary.

Exchange-rate stability

Moreover, if one excludes fresh food and energy, Japan’s inflation rate is much lower – 1.6% in August. That is below the 2% inflation target that has been in place since January 2013. As long as Japan’s inflation rate differs so sharply from those of the US and Europe, so must its monetary policy. Ensuring exchange-rate stability is part of the finance ministry’s mandate, not the BOJ’s. When the ministry intervenes in foreign-exchange markets to rein in volatility, it is doing its job, just as the BOJ is doing its job when it adjusts interest rates to ensure price stability. The authority of each embodies a complementary division of responsibility.

In any case, the main drivers of the yen’s depreciation are outside the control of both the ministry and the BOJ. Energy prices have been driven up by the war in Ukraine and, more recently, the OPEC+ decision to cut oil output. And the US dollar has been bolstered, vis-à-vis all major currencies, by the Fed’s monetary tightening.

Economic fundamentals

If the yen suddenly depreciates sharply against the dollar – say, because of speculative activities – the finance ministry may intervene again. But as long as current economic fundamentals and external conditions hold, the yen will continue to depreciate, and Japan will continue to import inflation. Only if conditions change – in particular, if US inflation declines – can Japan expect to reverse yen depreciation in any lasting way.

In the meantime, there might be a way for Japan to ease the pain of inflation. Japanese multinationals can pass along the profits their foreign businesses are accruing, thanks to the weak yen, to workers in Japan. With that, cost-push inflation would become demand-pull inflation, and the BOJ might, in the medium term, finally lift inflation to its 2% target in a sustainable manner. It would then be time to start increasing the policy rate and the long-term interest rate, which would help to slow the yen’s decline without hurting the domestic economy.

____________________

Takatoshi Ito, a former Japanese deputy vice minister of finance, is a professor at the School of International and Public Affairs at Columbia University and a senior professor at the National Graduate Institute for Policy Studies in Tokyo.

Copyright: Project Syndicate, 2022.

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