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Japan's Recent Currency Troubles Explained

With interest rates below zero, banks had to pay to park their excess reserves at the central bank. It aims to stimulate economic growth, encourage lending but negative interest rates can also diminish the attractiveness of the yen

Photo by Pema Lama / Unsplash

In recent years, the value of the Japanese yen has experienced a downward trend against major global currencies. This decline has significant implications for the Japanese economy and international trade.

Several factors contribute to this depreciation, including interest rates, monetary policy, economic stagnation, and the intervention of the Japanese government. In this article, we will delve deeper into these factors and their impact on the value of the yen.

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Interest Rates

One influential factor in the depreciation of the yen lies in the disparity between interest rates in Japan and other countries, notably the United States. When the US Federal Reserve raises its main interest rate, it makes the US dollar more appealing to investors. Consequently, there is a reduced demand for currencies from countries with lower interest rates, such as Japan, leading to a decline in their value relative to the US dollar.

Monetary Policy

The monetary policy implemented by the Bank of Japan (BOJ) also plays a crucial role in the depreciation of the yen. The BOJ has maintained ultra-low interest rates and signaled its commitment to supporting the economy. This stance indicates that the BOJ is in no rush to scale back its massive stimulus program. Such a policy approach can contribute to a drop in the value of the yen.

Economic Stagnation
Another factor influencing the weakening yen is Japan's persistent economic stagnation. The Japanese economy has struggled to sustain significant growth over the last three decades. Consequently, Japan has become the world's most indebted nation. Additionally, demographic challenges, such as a low birth rate and an aging population, further exacerbate the economic predicament. Experts believe that the weak yen reflects the underlying financial woes faced by Japan.

Government Intervention
The Japanese government has the capability to intervene in the foreign exchange market to control abrupt movements in the yen's value. However, despite their efforts, the market does not always respond as anticipated, and the yen continues to depreciate. These interventions are often unpredictable, making it challenging for authorities to reverse the trajectory of the yen.

BOJ and the local currency

The Bank of Japan (BOJ) has been employing a variety of monetary policies to devalue the yen and stimulate economic growth and inflation. These policies include Yield Curve Control (YCC), negative interest rates, and quantitative easing (QE). By implementing these measures, the BOJ aims to keep borrowing costs low, encourage lending and investment, boost exports, and spur domestic production. However, it is essential to assess the potential positive and negative consequences that a weaker yen can have on the Japanese economy.

Yield Curve Control (YCC)

One of the strategies employed by the BOJ includes Yield Curve Control (YCC). Through YCC, the BOJ aims to maintain the yield on the 10-year Japanese government bond (JGB) at around 0%. This policy is designed to stimulate economic growth and inflation by keeping borrowing costs low, thereby encouraging lending and investment. The BOJ has also made adjustments to its YCC policy, allowing the 10-year JGB yield to rise above the current cap of 0.5% to 1%. Such flexibility can contribute to a drop in the value of the yen.

Negative Interest Rates

In addition to YCC, the BOJ has implemented negative interest rates. By keeping its main interest rate below zero, banks are compelled to pay to park their excess reserves at the central bank. This policy aims to stimulate economic growth and inflation by encouraging banks to lend more. However, negative interest rates can also diminish the attractiveness of the yen to investors, leading to a decrease in its value.

Quantitative Easing (QE)

Quantitative easing (QE) is another monetary policy adopted by the BOJ to influence the value of the yen. The BOJ purchases large quantities of government bonds and other assets, such as exchange-traded funds (ETFs), in an effort to inject money into the economy and stimulate lending and investment. The objective is to promote inflation and weaken the yen. However, it is important to note that QE can also lead to inflation expectations and currency depreciation, which may cause the value of the yen to decline.

Positive Consequences

A weaker yen can have several positive consequences for the Japanese economy. Firstly, it can boost exports by making Japanese goods cheaper and more competitive in foreign markets. As a result, there is an increase in demand for Japanese products and services, which can contribute to a trade surplus. Secondly, a weaker yen can lead to higher profits for exporters when they sell their products abroad in foreign currencies and convert them back to yen. Lastly, a weaker yen can make Japanese products more affordable and appealing to domestic consumers, stimulating domestic production.

Negative Consequences

However, there are also potential negative consequences associated with a weaker yen. Firstly, higher import costs can arise, particularly for commodities like food and energy. This can reduce the purchasing power of domestic households and firms. Secondly, a weaker yen may lead to higher inflation due to increased costs of imported goods and raw materials. Consequently, the real value of wages and savings may decline. Lastly, a weaker yen can adversely affect domestic firms that rely on imported raw materials and components, as increased costs can reduce their competitiveness and profitability.