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Throughout this year, the Japanese yen has been depreciating, and on 3rd October, the Japanese yen weakened to its lowest for the year against the United States (US) dollar as the exchange rate was 1 USD = 150.17 Yen, as seen in Fig.1 . Though, the Yen did surge sharply after that, leading to the exchange rate rising to 1 USD = 147.30. The Yen’s depreciation has been partly due to the large gap between interest rates in Japan and the US. The difference in yields between the government bonds in the US and Japan has led to many selling the yen, increasing the supply of yen in the market. Much higher interest rates in the US would mean higher yields from bonds. Japan, unfortunately, is not in the position to be able to raise interest rates due to the fear of deflation. Over the years, the Bank of Japan (BOJ) has maintained an ultra-loose monetary policy, in a bid to stimulate demand and achieve inflation. A depreciation of the yen against the US dollar has impacted Japan’s economy in many different ways. This essay seeks to analyse the impact of the yen’s depreciation towards inflation and economic growth in Japan.
Fig.1: Depreciation of Japanese Yen due to increased supply of JPY
Price of JPY in terms of USD depreciates from e1 to e2 as supply of JPY increases from S1 to S2.
First, the impact of depreciation on Inflation in Japan. Over the past 25 years, Japan has always been known for being one of the few countries struggling with deflation. Since spring 2022, however, promising signs of price and wage increases gave Japan hope for the country’s economy to finally exit deflation. In January, core inflation in Japan rose to a 4-decade high as it stood at 4.2%, way above the Bank of Japan (BOJ)’s target of 2%. Up till recently, in September, Japan’s inflation rate still remains above 2%, albeit lower than 4.2%. Most of these increases are fueled by rises in input and raw materials costs, caused by the weaker yen. Firms facing higher input costs like higher energy costs. These costs are then passed on to the consumers, leading to cost-push inflation and core inflation in Japan rising, as seen in Fig 1. Prices of other basic necessities in Japan like food products have also risen. Yet, Cost-Push inflation has had its share of benefits for Japan in that it has led to unions pushing for wage growth to ensure Japanese can deal with the rising costs of living. Previously, unions never really pushed for low wages, which has led to lower demand and deflation in Japan. Wage growth has the potential to increase spending among Japanese. However, while it is good that there is inflation, the BOJ certainly prefers demand-pull inflation as compared to cost-push inflation. Demand-pull inflation would mean that Japan experiences higher growth while inflation occurs. Cost-Push inflation caused by the weakened yen has caused a rise in prices for many daily necessities for Japanese, which is a key issue that many Japanese have pushed back against the Kishida administration. Simultaneously, while wages have risen, the growth in real wages (growth in wages adjusted to inflation) has been minimal, as it continued to be below the real wage levels a year before. This has led to many Japanese calling for interest rates to be raised. One of the reasons why Japan’s yen has depreciated greatly is due to the stark differences in interest rates against the US. Stark contrasts in interest rates have resulted in major gaps in the yields of US and Japanese bonds. Bond yields in Japan are extremely low, with some even being negative. Hence, many Japanese hope for interest rates to be raised so that more people might purchase the yen, and the yen might strengthen, and costs of imported necessities would be less expensive. Unfortunately, the BOJ does not seem to show signs of abandoning its negative interest rate policy, as it still fears possibilities of deflation. It seems that Kishida and the BOJ would only abandon the loose monetary policy once wage growth is stable and there is a future path for growth to continue. As such, with the depreciation of the yen, Japan has been able to escape deflation, but the inflation that the Japanese are facing has not been beneficial for Japanese as prices of daily necessities rise.
Fig.2: Cost-Push Inflation in Japan
Prices increase from PL1 to PL2 due to the Short Run Aggregate Supply (SRAS) decreasing from SRAS1 to SRAS2 due to rises in input costs.
Second, the depreciation of the yen has also played a role in Japan’s economic growth. Growth in Japan has actually been promising, with its economy rising at a rate of 6% in the second quarter, which is one of the highest it has reached since the mid-1990s. One key reason for the rise in its growth was export growth, aided with a depreciation in the yen. As the value of the yen depreciated against the value of currencies around the world, like the United States (US) dollar, Singapore Dollar, exports from Japan became much more affordable. As prices of exports drop, demand for these exports increase, leading to increase in quantity of exports and subsequently a rise in export revenue. One industry that has contributed to the rise in exports is the tourism industry. A year after Japan reopened its borders for tourism, tourism has risen exponentially, with arrivals to Japan reaching 2.15 million in August, and many spending high amounts in Japan. China constitutes the most out of the 2.15 million individuals and they are also one of the top spenders in Japan. Some other industries have also benefitted from the depreciation of the yen. Industries that have also benefited from a weaker yen include the automobile and the semiconductor industry, who usually earn profits in foreign currencies when they export. With a weaker yen, their profit denominated in yen becomes larger. Yet, at the same time, imports for Japan shrinked, with importers feeling the pain, as prices of imports increased due to the weaker yen. As prices of imports rise, the amount of imports shrinked. With the balance of trade being an aspect of Gross Domestic Product (GDP), an increase in exports and decrease in imports leads to an increase in the balance of trade, leading to a rise in GDP. Hence, the depreciation of the yen has brought benefits to its trade balance and as a result, its GDP.
However, after an initial trade surplus for Japan in June, Japan faced a trade deficit as of August 2023. Japan could still face a trade deficit because the demand for its imports is quite inelastic. Much of its imports are energy, food and raw materials, goods that have a more price-inelastic demand. If Japan’s trade deficit persists, it would exert downward pressure on the yen, as there are more people selling the yen than people purchasing the yen. Greater pressure on the yen would subsequently result in a weaker yen and imports becoming even more expensive for Japanese. Concurrently, exports might become even cheaper as well. Though, it is worth noting that Japan’s top exports are automobiles, automotive parts and semiconductors, which might have a rather price-inelastic demand, but the demand for these goods are definitely less price-elastic than food, energy and raw materials that Japan imports. Thus, a further depreciation in the yen might have a more significant impact on imports than exports, since the demand for imports are more price-inelastic. For the second quarter, certainly the effect was stronger for exports. However, such demand might not persist in the long run. It is evident that there could be setbacks to its export growth. A specific example would be China’s seafood import ban on Japan, with food exports to China dropping by 41.2% as compared to last year. Demand for exports from China has also been concerning, leading to Japan’s overall exports to China dropping by 11.0%. If the demand for exports to China remains concerning, the trade deficit in Japan could persist, or further deepen. Japan might suffer economic contractions in the long-run. This would lead to a vicious trap, where Japan would find it difficult to escape the trade deficit, and the BOJ might have to intervene either by selling their foreign reserves to purchase Japanese Yen or abandon its negative interest rate policy. Though, the latter seems unlikely, considering the BOJ being committed to maintaining its negative interest rate policy until there is stable wage growth and sustained demand in the country. Thus, it seems that Japan might face difficulties in relying on an increase in its balance of trade for growth, as the continued depreciation of the yen has led to increased prices in imported necessities, while the demand for exports remains uncertain.
Another aspect of the GDP that has been impacted by the weak yen is investment towards Japan by foreign firms, as investments from these firms have risen. Japan has always been an attractive destination anyways with great infrastructure and a stable economic climate so many foreign firms have taken the opportunity to invest in Japan when the yen is weak. At the same time, in East Asia, investing in Japanese firms serves as a great alternative to China for countries allied to the US, since the US has started to reduce their investments in China. These allied countries likely would want to follow in the US’ footsteps. Hence, the depreciation of the yen has brought about some benefits for Japan’s growth, such as in investment and export growth.
In conclusion, the impact of the depreciation of the Japanese yen against the dollar has had a multifaceted effect on Japan’s economy. On one hand, the depreciation has increased revenue for firms in the exporting industry, however, the depreciation has compounded the increases in prices of imported necessities. The demand for exports remains uncertain in the long-term with Japan losing a lot of export revenue from its major trading partner, China. The price-inelastic demand of the necessities that Japan imports could also lead to Japan’s trade balance worsening, which could put further downward pressure on the yen, which might subsequently increase import costs again. As for Japan’s inflation, the depreciated yen has worsened it with the occurrence of cost-push inflation. Even though the cost push inflation could help Japan avoid deflation, it is not the ideal type of inflation a country wants. Hence, the depreciation of the yen is overall a negative sign in Japan’s economy, and the BOJ might need to intervene to prop up the currency so that they can avoid some of these negative consequences in growth and inflation.
References
Diagrams taken from, "Tragakes, Ellie. Economics for the IB Diploma. 3rd ed. 2009. Reprint, Cambridge University Press, 2020."
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