deflation[1] - Page 1 of 3 The yen On the...

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The yen On the slide Jan 3rd 2002 From The Economist print edition Can a cheaper yen rid Japan of deflation? THE yen, like the Japanese economy, had little to celebrate in the closing days of 2001. After trading in a range of ¥115-125 to the dollar for most of the year, the currency fell by 7% in December, to ¥132, its lowest for more than three years. A cheaper yen is exactly what Japan needs; but if the slide continues, expect a lot more griping from other Asian governments. Devaluation is one of the few policy tools left in Japan to fight deflation. Massive public-sector debts, and interest rates near zero, leave little room for further monetary or fiscal stimulus. A weaker yen could boost exports. More important, by raising import prices it could help to curb deflation and so push down real interest rates. Rumours that the Bank of Japan might start buying foreign bonds in order to drive the yen down helped to trigger its recent decline. Since then, the bank has explicitly rejected such a policy. The yen's depreciation appears largely to reflect investors' waning confidence in the Japanese economy, especially its financial system. The Ministry of Finance, which controls Japan's foreign-exchange reserves, argues that the yen's slide is driven by the market, and that it has no plan to drive the currency down through intervention. The government almost certainly welcomes a weaker yen, but it does not want to be seen to be pursuing an explicit policy of devaluation in the face of increasing complaints from the rest of Asia. Officials from China and South Korea have warned that a depreciation of the yen risks tit- for-tat devaluations in the region, creating economic instability. China's own concerns are overstated. By most measures, the yuan is significantly Page 1 of 3 1/27/2003
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undervalued. China's competitiveness is being bolstered by rapid productivity growth. Normally, this would be matched by higher wages or a stronger currency. However, wages are held back by a large pool of surplus labour, and China's partially convertible currency is pegged to the dollar. Even if the yen fell further, China would not need to devalue. A weaker yen might also have less serious consequences than is commonly believed for other Asian economies. Deutsche Bank reckons that even South Korea, whose exports compete more directly with Japan than do China's, is unlikely to suffer much harm from a weaker yen. The bank argues that when, in 1995-98, the yen fell sharply against the dollar (and hence the Korean won, which was then pegged to the dollar), Japan did not grab any market share away from South Korea. South Korea's exports continued to grow faster than Japan's. Indeed, adjusting for differences in inflation over time, most Asian currencies still
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deflation[1] - Page 1 of 3 The yen On the...

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