By Frances Coppola
Whenever there is economic or political turmoil somewhere in the world, investors tend to sell assets perceived as risky and buy assets they perceive as safe. The yen is one of these "safe haven" assets, along with yen-denominated stocks and bonds, Swiss francs and Swiss government bonds, U.S. treasuries, and gold.1
The yen has had a floating exchange rate since the failure of the Louvre Accord in the late 1980s. However, since Japan imports virtually all its oil and is therefore import-dependent despite being a net exporter,2 the BoJ actively intervenes in FX markets to limit the effect of exchange rate movements on domestic prices.
The fact that investors tend to regard the yen as a safe investment is a measure of confidence in the Japanese economy and its institutions. But it is something of a double-edged sword, since it can make it difficult for the BoJ to control the yen's exchange rate. For example, a rising yen exchange rate tends to put downwards pressure on inflation, which can lean against the BoJ's efforts to stimulate the economy and raise inflation.
The BoJ has had operational independence since 1998, when the current Bank of Japan Act came into force. Like the European Central Bank (ECB), the BoJ has a single mandate. Article 2 of the Bank of Japan Act says that monetary policy should be "aimed at achieving price stability, thereby contributing to the sound development of the national economy."3 There is no mention of unemployment or growth as primary or secondary targets, as with other central banks such as the U.S. Federal Reserve and the Reserve Bank of Australia.
During the 1990s, when other central banks were using monetary policy to prevent inflation from rising, the BoJ was trying to stop it falling. In the late 1980s, the Japanese economy went through a period of fast growth, fueled by expansionary monetary and fiscal policy, and by a weak yen exchange rate after the Louvre Accord of 1987. But after a stock market crash in 1989, the economy entered recession. Although the recession was mild, economic growth never recovered.4
By the time the Bank of Japan Act was passed in 1997, the economy had been growing at 1 percent per annum or less since 1991, inflation had been at or below zero for most of the decade, and interest rates had fallen from 8 percent in 1989 to 0.5 percent.5Inflation influences exchange rates: thus, Japan's persistently low inflation relative to its trading partners helped to keep the yen's exchange rate high during this time. Further, in 1997 a financial crisis in Asia caused the failure of two of Japan's major banks, after which the economy once again went into recession. So the BoJ's first task as an independent central bank was not to prevent inflation but to create it.6
However, the BoJ's attempts to generate inflation were ineffective. Despite very low interest rates and quantitative easing (QE), inflation hovered at around zero for the next 15 years and the yen's exchange rate remained correspondingly strong. Since central bank signaling influences future inflation expectations, the BoJ's lack of a clear inflation target and the unenthusiastic attitude of some of its officials to raising inflation may perhaps explain why expansionary monetary policy failed to raise inflation.7 The 10 years of stubbornly low inflation and weak GDP growth that preceded the 2008 financial crisis are now known as Japan's "lost decade."8
After the 2008 financial crisis, the yen's exchange rate strengthened. This was partly due to "safe haven" effects,9 and partly also to the unwinding of yen carry trades: as U.S. interest rates approached Japan's, the pre-crisis practice of borrowing in yen and lending in dollars became unprofitable.
But Japan was not immune from the crisis. Like most countries, it went into recession,10 and this was followed in 2011 with a further shock in the form of an earthquake and tsunami which caused serious damage to the Fukushima nuclear plant.11 The yen's strengthening exchange rate at a time of domestic economic turmoil once more pushed inflation below zero.12
In 2013, a new Prime Minister, Shinzo Abe, was elected. He appointed a new Governor for the BoJ, Harohiko Kuroda. Together, the two men devised a coordinated program of monetary and fiscal stimulus to kick start the stagnant Japanese economy and get inflation off the floor.13 As part of this program, the BoJ for the first time adopted a formal inflation target of 2 percent.14 For an economy that had rarely experienced inflation much above zero in over twenty years, this was highly ambitious.15
Although the yen's exchange rate is not an explicit target of either monetary or fiscal policy, the BoJ's massive QE program was expected to weaken the yen versus other major currencies.16 However, the yen's exchange rate has not fallen much. Indeed, during the summer of 2016 it actually strengthened, reaching 101 to the U.S. dollar in September 2016.17
Despite negative interest rates18 and asset purchases on an unprecedented scale,19 inflation has remained well below the 2 percent target,20 except in 2014-15 when the government briefly raised sales taxes.21
The BoJ's inability to raise inflation is in part due to monetary policy in other countries: very low interest rates and QE, along with prolonged economic stagnation since the 2008 crisis, have tended to keep the exchange rates of major currencies such as the U.S. dollar and the euro low versus safe haven currencies like the yen. Rising interest rates in the U.S., and the start of Fed balance sheet reduction, could cause the U.S. dollar exchange rate to rise versus the yen, which would tend to raise inflation in Japan. However, forward guidance from the Federal Reserve that interest rates will continue to rise has so far had no discernible effect on the yen's exchange rate, which has hovered at around 110 to the dollar since the beginning of 2017.22
Some also argue that Japan's persistently low inflation and GDP growth have deeper, structural cause. Japan's population is ageing fast, and ageing populations are thought to prefer saving over spending. Additionally, business investment has been weak. It may be that Japan's stagnation is due as much to these structural factors as its "safe haven" exchange rate and the BoJ's monetary policy.23
The yen's "safe haven" status tends to make the yen's exchange rate stronger than might be expected given Japan's persistently low economic growth. For foreign businesses, the strong and relatively stable exchange rate could make exporting to Japan attractive.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Safe haven,” Investopedia; http://www.investopedia.com/terms/s/safe-haven.asp
2. “Japan is the second largest net importer of fossil fuels in the world,” U.S. Energy Information Administration; https://www.eia.gov/todayinenergy/detail.php?id=13711
3. “Price Stability and the price stability target of 2 percent,” Bank of Japan; https://www.boj.or.jp/en/mopo/outline/index.htm/
4. “Japanese monetary policy: 1998-2005 and beyond,” Takatoshi Ito; http://www.bis.org/publ/bppdf/bispap31i.pdf
8. “Japan’s lost decade,” The Guardian; https://www.theguardian.com/business/2008/sep/30/japan.japan
9. “Japan-US Foreign Exchange rate,” FRED Economic Data; https://fred.stlouisfed.org/series/EXJPUS
10. “Japan’s economy, world’s third largest, is in recession,” The New York Times; http://www.nytimes.com/2008/11/17/business/worldbusiness/17yen.html?mcubz=1
11. “Fukushima Accident,” World Nuclear Association; http://www.world-nuclear.org/information-library/safety-and-security/safety-of-plants/fukushima-accident.aspx
12. “Japan CPI inflation,” FRED Economic Data; https://fred.stlouisfed.org/series/FPCPITOTLZGJPN
13. “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth,” Bank of Japan; https://www.boj.or.jp/en/announcements/release_2013/k130122c.pdf
15. “Japan’s economy: credibility on the line,” Financial Times; https://www.ft.com/content/4b26258e-7c86-11e5-a1fe-567b37f80b64
16. “Abenomics propels yen weakness,” Financial Times; https://www.ft.com/content/dbdc8d5c-b8d9-11e2-869f-00144feabdc0
17. “Japan-US Foreign Exchange rate,” FRED Economic Data; https://fred.stlouisfed.org/series/EXJPUS
18. “Japan adopts negative interest rate in surprise move,” BBC; http://www.bbc.co.uk/news/business-35436187
19. “BoJ’s total assets climbs to top 500tn yen for the first time,” The Japan Times; https://www.japantimes.co.jp/news/2017/06/02/business/bojs-total-assets-climbs-top-%C2%A5500-trillion-first-time/#.Wc2ZiciGM2w
20. “Japan CPI inflation,” FRED Economic Data; https://fred.stlouisfed.org/series/FPCPITOTLZGJPN
21. “Japan raises sales tax for first time in 17 years,” BBC http://www.bbc.co.uk/news/26830486
22. “Japan-US Foreign Exchange rate,” FRED Economic Data; https://fred.stlouisfed.org/series/EXJPUS
23. “The structural causes of Japan’s lost decades,” Fukao et al; http://www.worldklems.net/conferences/worldklems2014/worldklems2014_Fukao.pdf
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