South-Western College Publishing - Economics  
A Reverse in the Yen
Subject Monetary Policy
Topic International Finance
Key Words Depreciation, Appreciation, Exchange Rate Exchange Rate
News Story

Since mid-July, much to the surprise of the international financial community, the Japanese yen has risen about 15 percent relative to the dollar. The Japanese economy has been in recession for the past seven years but has recently shown signs of recovering. This recovery has attracted increased foreign investment, which, in part, has put upward pressure on the yen. The Group of Seven (G-7), an association of the largest industrial countries, has put pressure on Japan to stop the yen from appreciating. The United States and the other major countries have intimated that they would intervene in foreign exchange markets to weaken the yen and strengthen the dollar.

The United States had been pressing Japan to lower interest rates and continue spending heavily on public infrastructure and other measures to stimulate the economy. Japan was not going to implement these recommendations. Given that interest rates in Japan are virtually zero, effecting a decrease would be a difficult task. The Bank of Japan, in the face of political pressure from Japanese politicians, has refused to do so. Japan is currently running huge deficits and further spending would put it at risk of facing the kind of severe fiscal problems that the United States experienced in the 1980s.

Instead, Japan hopes to reverse the movement of the yen by trying to spur inflation. Increased inflation, it is believed, will weaken the yen and discourage Japanese consumers from spending. Before World War II, Japan went through a period of hyperinflation. Japan's experience with hyperinflation has kept post-World War II inflation to a minimum. Printing yen to induce inflation would be a significant change in strategy.

(Updated November 1, 1999)

Questions
1. Assuming a system of flexible exchange rates, the exchange rate of the dollar for the yen is determined by what factors?
2. Assuming that the central banks of the major industrial countries were interested in appreciating the value of their currency relative to the yen, how could they accomplish their goal?
3. What would be the effect of a lowered exchange rate on the Japanese economy? The U.S. economy?
Source David E. Sanger, "Japan Agrees To Rare Moves To Try to Halt Rise of Yen," The New York Times, September 26, 1999.

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