TOKYO — For years, as Japan tried to boost its chronically weak economic growth, it pursued what its central bank saw as a magic formula: stronger inflation and a weaker yen.
It didn’t quite work as intended. Inflation never met the government’s modest target, despite rock-bottom interest rates and heaps of fiscal stimulus. Workers’ wages stagnated, and growth remained anemic.
Now, Japan is suddenly getting what it wished for — just not in the way it had hoped.
While overall inflation remains moderate, food and energy costs are rising rapidly, an outgrowth not of increased demand, but of market turmoil related to the pandemic and Russia’s invasion of Ukraine. And the yen has hit a two-decade low against the dollar, a dizzying drop of more than 18 percent since September that has unnerved Japanese businesses.
The twin forces are posing yet another challenge for the world’s third-largest economy as Japan trails other major nations in emerging from the economic blow of the pandemic. The rise in prices has spooked Japanese consumers used to decades of stability, and the weak yen is starting to look as if it will depress demand at home more than stimulate it abroad.
“The yen depreciation is attacking the weakest point of the economy,” said Takahide Kiuchi, an economist at the Nomura Research Institute who served on the Bank of Japan’s policy board. Households, he said, “are facing an increase in prices of every imported good,” and “the situation is undermining consumer sentiment even in advance of actual inflation.”
The worries about the depreciating yen reflect a gradual shift in the Japanese economy over the past decade.
In a previous era, when Japan was a manufacturing superpower, a weak yen would have been cause for celebration, making Japanese exports cheaper abroad, increasing the value of revenue earned overseas and attracting foreign investment.
But exporting is now less important to the overall Japanese economy, and companies — seeking to avoid trade restrictions and take advantage of cheaper labor costs — have begun to produce more of their products overseas, reducing the impact of exchange rates on their bottom line.
A Bank of Japan report released in January found that although a weak yen continued to aid the economy, its positive impact on exports had shrunk over the decade leading up to the pandemic. Its contribution to inflation, however, had increased during the same period.
The pandemic and the war in Ukraine have most likely amplified the negatives and diminished the positives, said Naohiko Baba, chief Japan economist at Goldman Sachs. Prices have been rising because of manufacturing shutdowns in China and broader logistics chain snarls, as well as the war’s impact on exports of Ukrainian wheat and Russian gas and oil.
For resource-poor Japan, which is highly reliant on imported fuel and food, the drop in the yen has driven 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 one brand of convenience store chicken had 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,” Mr. Baba said. He added that the potential upside of the currency devaluation had been further reduced by Japan’s decision to continue barring international tourists, who might be eager to take advantage of favorable exchange rates.
There are a number of reasons for the yen’s weakness. Japan’s economy has faltered during the pandemic, and skyrocketing commodity prices have forced importers to sell more yen for dollars to pay their bills.
But the main cause, experts say, is Japan’s insistence on maintaining interest rates at near zero even as other central banks, led by the Federal Reserve, raise their own drastically.
The widening spread has triggered a rush to buy dollars as investors look for better returns. And the exodus seems likely to continue.
Last week, the Fed raised interest rates by half a point, the largest jump in over 20 years, and it has said that it intends to continue raising borrowing costs as it seeks to cool rapid inflation stoked by a booming American job market and rising wages.
Wages in Japan, by contrast, have barely budged, and the country’s high employment levels have remained comparatively steady. That means that Japan’s inflation, which over all remains under the government’s target of 2 percent, is most likely driven by supply-side issues caused by the war and the pandemic, not the increased demand that low interest rates are intended to produce.
In theory, the Bank of Japan could stanch the yen’s devaluation by raising interest rates. But its governor, Haruhiko Kuroda, whose term ends next April, seems set to stick with his policies until he achieves inflation of both the quality and quantity he envisioned nearly a decade ago when he was nominated by then-Prime Minister Shinzo Abe.
Modest inflation driven by consumer demand, the thinking goes, would create a virtuous cycle of economic expansion: Companies’ profits would grow, spurring investment, wage growth and domestic consumption.
In late April, Mr. Kuroda doubled down on his commitment to low rates, increasing the Bank of Japan’s purchases of government bonds. The announcement was followed by a yen sell-off.
Even if Mr. Kuroda wanted to raise rates, doing so may set off 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 raising rates could both make that approach more difficult to continue and make Japan’s national debt, which stands at over 250 percent of its annual economic output, harder to service.
While economists disagree about whether that level of debt is sustainable, policymakers are not eager to chance it.
“High inflation is politically toxic, and trying to correct for it, 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 has brushed off suggestions that the Bank of Japan should seek to strengthen the yen by raising interest rates.
Instead, he has sought to combat rising prices with more stimulus. This year, Parliament has signed off on several rounds of subsidies to Japanese oil companies that are intended to lower gas prices. In April, lawmakers announced an additional round of subsidies and direct cash payments of about $380 to families with children.
Some politicians have suggested that the Bank of Japan could shore up the yen’s value through currency market interventions, selling its own dollar holdings to lift the Japanese currency. But that’s an expensive proposition that is 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 gotten so big that the actual intervention doesn’t change it. It might change it for a few days, but it won’t change the trend.”
With few practical options, the one thing Japan can try to do is “talk the yen up,” she said, with officials making a full-court press to convince markets that they will protect the currency’s value. However, “that requires other partners in the U.S. and Europe to help,” she said, and they are too busy handling their own economies’ problems to devote much thought to Japan.
“They don’t care too much about the depreciating yen at the moment,” she said.
That means Japan may need to just hang tough until things turn around, said Sayuri Shirai, an economics professor at Keio University in Tokyo and a former member of the Bank of Japan’s board.
U.S. interest rates will “not expand forever,” she said. “I think we shouldn’t be panicked.”