There are plenty of reasons why Japanese policymakers might favor a stronger yen. With Japan increasingly reliant on both imported food and imported energy, anything which increases the nation’s international purchasing power can be seen as positive. But the supposed benefits of a stronger currency run beyond that obvious implication. It helps to support household savings too, a crucial factor in a country such as Japan with aging demographics. What is more, for a fair few decision makers at both the Finance Ministry and the Bank of Japan, periods of yen weakness bring to mind fears of the years before 2008 when a similar long stretch of a weak yen was seen as camouflaging underlying economic weakness and causing even more turmoil when the yen appreciated sharply during the early stages of the Global Financial Crisis.
Of course, as in much of macroeconomics, the case is far from clear cut. A weaker yen is not without its advantages. Not only does it provide some support for exporters but it may well be helpful for Japan’s wider inflation dynamics. Earlier this year the Bank of Japan hailed signs of a “virtuous inflationary cycle” with wage growth picking up in the face of rising prices. After more than two decades of weak – or even negative – inflation rates, the Bank of Japan is one of the few leading global central banks for whom a wage-price spiral is something to celebrate. In recent months the rate of headline inflation in Japan has ticked down and anything that provides a touch more price pressure – such as a weaker currency – could actually prove beneficial in the medium term.
But whatever Japanese policymakers might desire when it comes to the value of the yen, the financial markets have their own ideas.
At the beginning of 2022, one US dollar was worth around ¥115 but by the start of 2023 it took ¥130 to acquire one dollar. By the beginning of this year, the rate had moved to around ¥140. In recent weeks it has approached ¥160.
There are sound fundamental reasons for this weakness. Mostly the movements reflect changing expectations about the path of interest rates in Japan and the United States. Whilst the Bank of Japan was finally able to move rates out of negative territory in March this year, after 8 years below zero, its key policy rate remains just 0.1%. Meanwhile, as US inflation has proven to be more stubborn than the markets initially hoped would be the case, expectations of the path of Federal Reserve policy rates have been repriced over the past six months. The end result is that the rate differential is larger than was expected and that is expected to continue. All things being equal, to use an economist’s favorite phrase, makes holding US dollars relatively more attractive than holding yen and tends to cause the yen to depreciate against the dollar.
Grumbling about the level of market-determined exchange rates is hardly a trait unique to Japanese policymakers, at least in private one can occasionally hear similar things from officials at both the Bank of England and the European Central Bank. What is more specifically Japanese is the fact that policymakers are sometimes prepared to put their money, in the form of the country’s sizeable foreign exchange reserves, where their mouth is and actively intervene in the foreign exchange market. Something which is nowadays comparatively rare amongst their peers.
Nor was this the only intervention in the current bout of yen weakness, with Japanese policymakers actively intervening in the market on three occasions over the course of 2022.
But can active interventions actually achieve much if they are both unilateral and pushing against the underlying interest rate fundamentals? The Clark Center’s Finance Experts Panel considered this very question last week. The results do not make for cheerful reading for Japanese policymakers.
Asked whether large-scale interventions by the public authorities in currency markets can move exchange rates substantially, there was widespread agreement that they could. Weighted by confidence 19% of respondents strongly agreed with the proposition and another 54% agreed.
But asked whether the effectiveness of such interventions could last beyond a month, that strong consensus almost evaporated. Again weighted by confidence, a plurality of expert respondents were uncertain, 38% agreed and 20% disagreed. Hardly a ringing endorsement of the likely success of the policy.
Japan, with more than $1.3 trillion of reserves – the second highest total of any country, has the ability to materially intervene for many months ahead. But whether or not, in the absence of a shift in underlying monetary policy, that will have much effect remains an unopened question. Currency intervention will probably remain big in Japan, but less common when it comes to other major world central banks.
