The yen is the official currency of Japan. After the US dollar and Euro, it’s the third most traded currency on the foreign exchange market. Exchange rate relates the value of a currency in terms of another. Some countries peg their currency to another, usually the US dollar, to minimise the exchange rate volatility and achieve economic stability – this is called a fixed exchange rate. Conversely, an exchange rate determined purely by the market force and lacks government intervention, is called a free-floating exchange rate.
Japan’s exchange rate control system is quite unique. The dollar to yen currency exchange rate usually sits somewhere around 1 US dollar per = 99.3774 Japanese Yen. However, Japan doesn’t necessary peg their currency to a specific value of US dollar. Instead, the Japanese government tries to devalue their yen and keep their yen cheaper in relative to the US dollar. This is achieved by increasing the inflation rate.
Firstly, through increasing the inflation rate, devaluation of yen can be achieved. Inflation is defined as a sustained increase in the general price level. Figure1 shows the inflation rate for Japan, over the past decade. (2009-2019). Shown in figure1, the inflation rate is frequently below the targeted rate of 2%, due to the economic stagnation that Japan has been experiencing after the collapse of asset price bubble in late 1991, so called the “Lost Decade” (https://en.wikipedia.org/wiki/Lost_Decade_(Japan)). To fight the on and off deflation, Prime Minister Shinzo Abe’s policy “Abenomics”(Involves fiscal expansion and structural reform) launched in 2013, which resulted in the large increase of inflation and depreciation of yen, as shown in Figure2.
Figure1: The rate of inflation 2009-2019
Figure2: Exchange rate of yen in relative to the 1 US dollar 2009-2019
There is advantage of maintaining Japanese yan cheaper than the US dollar. Keeping yen cheap, in relative to the US dollar is beneficial to the Japanese economy because Japan can maintain the large amount of exports to the US. In fact, Japan is one of the biggest exporters to the US – exporting nearly 145-billion-dollar worth of products/service to US in 2018. When yen is cheap, with the same amount of US dollar, more of the Japanese products can be bought – thus, Japanese products becomes more competitive. Also, since depreciation of yen means that with the same amount of yen, less US dollar can be exchanged. i.e. less products of US can be bought, the products from US loose competitiveness and imports of US products to Japan decrease. This increase in export and decrease in import together contributes to the shrink of trade deficit.
However, there are some potential problems and disadvantages to peg Japanese yen cheaper than the US dollars by controlling the inflation rate. Firstly, to increase inflation rate, policies such as expansionary monetary policy, expansionary fiscal policy is used. These policies frequently conflict with the economic objectives of the country. For instance, in “Abenomics”, expansionary monetary policy was used to boost aggregate demand. This requires government to spend large quantity of funds and may lead to the worsening of the heavy debated Japanese government’s financial budget. Thus, pegging yen’s exchange rate may leads to sacrifice of other economic objects. In addition, with this method, economics stability and safety can’t be achieved, as yen isn’t pegged to the US dollar, but rather simply, controlled to be cheaper than the US dollar – The degree of how cheap it should be remained isn’t decided. Lastly, there are potential risks of pegging lower than the US dollar, for the sake of exporting more to the US. It creates a situation where Japan’s economy may be overly reliant on the US economy. Although many developed countries are already very interdependent, a recession in US, or the depreciation of US dollar can result in extremely serious damage to Japan. Under such circumstance, Japan may have to revise their currency control system.
To conclude, Japan peg it’s currency cheater then the US dollar, to maintain its export competitiveness. One of the policies used was to increase inflation to creates depreciation of the yen. While it is effective in achieving the aim, like many policies, there are some potential disadvantages. However, considering how much Japan benefit from its trade surplus with US, it’s fair to say that pegging currency cheaper than US dollar is beneficial.