Time of Troubles: The Yen and Japan’s Economy, 1985–2008

Abstract

Japan’s real economic growth rate generally shows a strong negative correlation with the level of the yen’s real effective exchange rate. In light of the development of Japan’s macroeconomy, however, the determinants of the yen’s short- and even longer-term movements remain poorly misunderstood. This chapter examines the interplay between monetary policy and the exchange rate during the period of Japan’s bubble economy and subsequent economic stagnation, and explains how monetary movements affect both the real exchange rate and the nominal exchange rate. It first analyzes Japan’s policy interest rates and then looks at the evolution of the yen’s real exchange rate with reference to international trade and inter-sectoral productivity growth gaps, as predicted by the Harrod–Balassa–Samuelson model, as well as fluctuations in relative international prices for traded goods, including energy.