Japan has long sought more inflation and a weak yen. But not like this.


TOKYO — For years, as Japan tried to boost its chronically weak economic growth, it pursued what its central bank saw as a magic bullet: higher inflation and a weaker yen.

It didn’t quite work as expected. Inflation has never reached the government’s modest target, despite rock-bottom interest rates and heaps of fiscal stimulus. Workers’ wages stagnated and growth remained sluggish.

Now Japan suddenly gets what it wanted – but not in the way it had hoped.

While headline inflation remains subdued, food and energy costs are rising rapidly, a consequence not of increased demand but of market turbulence linked to the pandemic and the invasion of Ukraine by the Russia. And the yen hit its lowest level in two decades against the dollar, a dizzying fall of more than 18% since September that has confounded Japanese companies.

The twin forces pose another challenge to the world’s third-largest economy as Japan lags behind other major nations in emerging from the economic blow of the pandemic. Rising prices have spooked Japanese consumers accustomed to decades of stability, and the weak yen is starting to look like it will depress domestic demand more than boost it overseas.

“The depreciation of the yen is attacking the weakest point in the economy,” said Takahide Kiuchi, an economist at the Nomura Research Institute who served on the board of the Bank of Japan. Households, he said, “are facing rising prices for every imported good” and “the situation is undermining consumer sentiment even ahead of actual inflation.”

Concerns about the depreciation of the yen reflect a gradual change in the Japanese economy over the past decade.

In earlier times, when Japan was a manufacturing superpower, a weak yen would have been cause for celebration, making Japanese exports cheaper overseas, increasing the value of income generated overseas, and attracting foreign investment.

But exporting is now less important to Japan’s economy as a whole, and companies – seeking to avoid trade restrictions and take advantage of lower labor costs – have begun to produce more of their goods at abroad, thus reducing the impact of exchange rates on their net income.

A Bank of Japan report released in January found that while a weak yen continued to support the economy, its positive impact on exports had diminished in the decade before the pandemic. However, its contribution to inflation had increased over the same period.

The pandemic and the war in Ukraine most likely amplified the negatives and dampened the positives, said Naohiko Baba, chief economist for Japan at Goldman Sachs. Prices rose due to manufacturing shutdowns in China and broader supply chain issues, as well as the impact of war on Ukrainian wheat and Russian gas and oil exports.

For resource-poor Japan, which relies heavily on fuel and food imports, the falling yen has pushed already high prices even higher, with the costs of some necessities rising by double-digit percentages. For the first time in over a decade, consumers are paying more for Asahi beer. And a brand of convenience store chicken saw its first price increase in more than 35 years.

“From the perspective of exporters, the weaker yen should be beneficial, but for others, it should be neutral or negative,” Baba said. He added that the potential benefit of currency devaluation had been further reduced by Japan’s decision to continue banning international tourists, who might be keen to take advantage of favorable exchange rates.

Several reasons explain the weakness of the yen. Japan’s economy faltered during the pandemic and soaring commodity prices forced importers to sell more yen for dollars to pay their bills.

But the main cause, experts say, is Japan’s insistence on keeping interest rates near zero even as other central banks, led by the Federal Reserve, raise theirs dramatically.

The widening spread has sparked a rush to buy dollars as investors seek better yields. And the exodus looks set to continue.

Last week the Fed raised interest rates by half a point, the biggest jump in more than 20 years, and said it intended to continue raising borrowing costs as it sought to quell rapid inflation fueled by a booming U.S. job market and rising wages.

Wages in Japan, by contrast, barely budged, and the country’s high employment levels remained relatively stable. This means that inflation in Japan, which remains broadly below the government’s 2% target, is most likely driven by supply issues caused by the war and the pandemic, not by rising demand. that low interest rates are supposed to produce.

In theory, the Bank of Japan could stem the devaluation of the yen by raising interest rates. But its governor, Haruhiko Kuroda, whose term ends next April, appears set to stick with his policy until he achieves the quality and quantity inflation he envisioned a while ago. nearly a decade when then Prime Minister Shinzo Abe appointed him.

Modest inflation fueled by consumer demand, it is thought, would create a virtuous circle of economic expansion: corporate profits would rise, boosting investment, wage growth and domestic consumption.

In late April, Mr. Kuroda doubled his commitment to low rates, increasing purchases of government bonds by the Bank of Japan. The announcement was followed by a sell-off in the yen.

Even if Mr. Kuroda wanted to raise rates, it could trigger a cascade of economic consequences, said Gene Park, a professor of political science and international relations at Loyola Marymount University who studies Japanese monetary policy.

Japan has come to rely on big spending to stimulate its economy, Mr Park said, and rising rates could both make that approach more difficult to pursue and make Japan’s national debt, which is more than 250% of its annual economic output, more difficult to manage. a service.

While economists disagree on the sustainability of this level of debt, policymakers are not eager to risk it.

“High inflation is politically toxic, and trying to fix that, the medicine, is also an extremely bitter pill,” Mr Park said. “If they raise interest rates, that’s also going to be unpopular.”

Like Mr. Kuroda, Prime Minister Fumio Kishida rejected suggestions that the Bank of Japan should seek to strengthen the yen by raising interest rates.

Instead, he sought to fight rising prices with more stimulus. This year, Parliament approved several rounds of subsidies to Japanese oil companies designed to lower gas prices. In April, lawmakers announced an additional round of grants and direct cash payments of about $380 to families with children.

Some politicians have suggested that the Bank of Japan could bolster the value of the yen through foreign exchange market intervention, selling its own dollar holdings to boost the Japanese currency. But it’s an expensive proposition that’s unlikely to have much effect, said Saori Katada, a professor of international relations at the University of Southern California who studies Japan’s trade and monetary policy.

“These days, the central bank has already given up on intervening in the market,” Ms Katada said. “The whole market has become so large that the actual intervention does not change it. It might change it for a few days, but it won’t change the trend.

With few practical options, the only thing Japan can try to do is “drive the yen higher,” she said, with officials doing all the press to convince markets they will protect the value of the currency. However, “it requires help from other partners in the United States and Europe,” she said, and they are too busy dealing with problems in their own economy to devote much attention to Japan.

“They don’t care too much about yen depreciation right now,” she said.

That means Japan may have to stand firm until things change, said Sayuri Shirai, an economics professor at Keio University in Tokyo and a former Bank of Japan board member.

US interest rates “are not going to go up forever,” she said. “I think we shouldn’t panic.”

Hisako Ueno contributed report.


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