Japan's Deflationary Hangover: The Syndrome of the Ever-Weaker Yen

Beginning in the 1970s with the emergence of Japan as America’s foremost industrial competitor, demands for both restraints on particular Japanese exports and appreciation of the yen became rampant in the U.S. As a result, the yen rose from 360 to the dollar in 1971 to touch 80 in April 1995, when U.S. Secretary of the Treasury Robert Rubin ended the episode by announcing a “strong dollar” policy. Subsequently, the yen has fluctuated but with no net appreciation. In 1997, Ronald McKinnon and Kenichi Ohno identified the “The Syndrome of the Ever-Higher Yen.” Actual yen appreciation and supporting monetary policy imposed a deflationary shock on the Japanese economy, and expected further appreciations drove nominal interest rates on yen assets toward zero—the dreaded liquidity trap—while slowing wage growth. Yen prices of tradable goods began to fall broadly in the mid 1980s; and they argued that the great asset bubbles in real estate and stock prices in the late 1980s were endogenous to the syndrome. After the bubbles burst in 1990-91, the negative shock to Japan’s economy was compounded by a further rise in the yen through April 1995—leading to Japan’s infamous “lost decade” from 1992 to 2002. Today, surprisingly, Japan still suffers from a deflationary hangover with wage stagnation and the near-zero-interest liquidity trap. Since 2003, however, output has begun to grow modestly through export expansion—the only way it can grow because domestic demand remains moribund within the liquidity trap. This export growth has been led, however, by a passive real depreciation of the yen: prices and wages in Europe and the United States have risen, and are rising, faster than in Japan. Thus the yen becomes ever-weaker in real terms—which one could now characterize as “The Syndrome of the Ever Weaker Yen.” Japan is trapped. If it appreciates, its fragile economy will be driven back into outright deflation.