The full picture of Sanaenomics, centered on "responsible and proactive fiscal policy," the centerpiece of the Sanae Takaichi administration's policies, is not yet clear, but it is evident that the administration is paying homage to and intends to bring about a resurgence of Abenomics, which consisted of three arrows, namely, bold monetary policy, flexible fiscal policy, and a growth strategy that stimulates private sector investment.
Yet the economic conditions in early 2013, when Abenomics was launched, were entirely different from today. In early 2013, the Japanese economy was suffering from low share prices and a strong yen under an environment where prices had not risen for many years. In the Nikkei article published on May 8, 2024, I pointed out that the achievements of Abenomics, and particularly the unprecedented monetary easing, were seen less in terms of direct impacts on the real economy and more in the resulting high share prices and weak yen.
Under the current circumstances where the Nikkei average is hitting fresh highs over 50,000 yen and the yen keeps weakening while ordinary people struggle with rising prices, an attempt to resurrect Abenomics would be futile or even harmful, erasing any potential benefits.
What about the large-scale fiscal stimulus amounting to 18.3 trillion yen under the supplementary budget? If high prices are caused by supply restrictions, then subsidies for consumers like rice coupons would only increase demand and subsequently raise market prices further.
In Japan, where for a long time people have experienced a world with no interest rates where prices have remained almost unchanged, it is possible that the basic principles of macroeconomics have been forgotten. When prices and interest rates begin to increase, any fiscal action naturally applies further upward pressure on prices and leads to an increase in long-term interest rates. The fact that the government bond market has started to react to fiscal stimulus is actually a sign of normalization.
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On the other hand, some of the phenomena that are currently being observed deviate from normal textbook macroeconomics cases, and one such example is the yen exchange rate. In a standard, open macroeconomic model, fiscal stimulus should create upward pressure on interest rates, pushing the yen toward appreciation. However, the yen's depreciation is continuing. Of course, it is known that if fiscal stimulus also boosts economic conditions in other countries, the yen-appreciating effect weakens, but that possibility is low in this instance.
In December 2025, the Bank of Japan raised the policy interest rate by 0.25%, but the market immediately reacted with a weaker yen. The market predicted that the BOJ would raise interest rates more slowly than had previously been expected. This market movement is consistent with existing experimental research showing that unexpected monetary policy shocks can affect exchange rates.
If the yen’s depreciation results from the market assuming that the central government had no choice but to take a negative stance toward interest rate hikes in order to avoid rapid increases in government debt servicing costs or volatility in the government bond market, then the issue is even more problematic. If the top priority of economic policy measures is coping with rising prices, policymakers should first sincerely address the weak yen head on, as the weak yen is aggravating price inflation.
The fact that the yen-US dollar exchange rate demonstrates excessive yen weakness at present is also evident in bilateral purchasing power parities between Japan and the United States by type of goods (see the Table). However, policymakers' ability to control exchange rates is limited, even considering foreign exchange interventions, and central banks are extremely reluctant to make the exchange rate a target of their monetary policy.
Recently, some argue that the weak yen is caused not by monetary policy but by Japan falling behind the United States in productivity increases in tradable goods, thus emphasizing real factors. This mechanism is known as the Balassa-Samuelson (BS) effect, named after two economists.
As a theory of long-term exchange rate determination, the purchasing power parity hypothesis states that nominal exchange rates are determined so that the price levels of two countries (Japan and the United States) become equal, or in other words, arbitrage allows for the achievement of one price for identical goods (the Law of One Price) in a basket of goods and services in the economy as a whole. However, in reality this theory does not hold, even in the long term.
For this reason, the real exchange rate, calculated as the ratio of price levels of the two countries, (i.e., domestic price level (yen) / foreign price level (dollar) x nominal exchange rate (yen/dollar)) can deviate from 1 (the expected value if the theory holds).
The BS effect explains the mechanism behind this deviation. Supposing that the Law of One Price holds through trade arbitrage in sectors producing tradable goods, such as manufacturing. If productivity in the domestic tradable-goods sector increases, wages will increase as the price of those goods is the same internationally.
Meanwhile, if the domestic labor market were a perfect market, labor mobility would equalize wages across sectors even causing wage increases in non-tradable-goods sectors like service sectors, eventually raising prices in those sectors. For example, the productivity of barber shops does not vary much by country, but the price of their services is higher in countries where the productivity of tradable goods is higher. Increases in prices of such non-tradable goods raise the overall price levels of the country and create upward pressure on real exchange rates.
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The long-term appreciation of the yen until the early 1990s has been considered as a representative example of the aforementioned BS effect becoming visible. On the other hand, there is an idea that the downward trend of real yen-dollar exchange rates thereafter is a result of an “adverse BS effect” caused by lower growth rates in the relative productivity of tradable goods against non-tradable goods in Japan compared with those in the United States. This idea is an argument emphasizing real-side factors. However, it seems unreasonable to overemphasize the adverse BS effect as a factor in the yen's depreciation trend that has continued for the last decade or so.
This is because the BS effect itself is premised on the Law of One Price holding for tradable goods, i.e., on changes in nominal exchange rates that make the condition hold. However, in reality, it has become clear that the deviation for tradable goods from the Law of One Price can persist for a long period of time. For example, if Japanese exporters do not change their local sales prices in the United States when an appreciation of the yen occurs, the Law of One Price fails, and if the goods are differentiated, price arbitrage also does not work.
If the Law of One Price does not hold for tradable goods, the terms of trade, or the ratio of the export prices (of domestic tradable goods) against the import prices (of foreign tradable goods), will also change, and this will affect real exchange rates. Some empirical analyses demonstrate that this effect is sometimes more significant than the BS effect.
If the Law of One Price is fulfilled for tradable goods and the growth rate of the relative productivity of tradable goods in Japan becomes lower than that in the United States, relative prices of tradable goods should become higher, but in reality, prices have continued to stagnate in Japan making export prices relatively lower than import prices, and worsening the terms of trade for Japan. Under such circumstances, if arbitrage in tradable goods were functioning properly, nominal rates should be subject to upward pressure (yen appreciation), contrary to the reverse BS effect that is often presented.
As a point of reference towards correcting the weak yen, purchasing power parities for durable goods and capital goods, which are considered to be tradable goods, as shown in the Table, may be useful. A hopeful sign for Japan’s economy would be to see progress towards genuine normalization in this year’s macroeconomic policy.
>> Original text in Japanese
* Translated by RIETI.
January 13, 2025 Nihon Keizai Shimbun
