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Next we will talk about Japans policies in dealing with the Yens rapid

appreciation against the US dollars. The Bank of Japan deals with the
problems of Yens appreciation along with the problem of deflation by
reducing its interest rate to a negative value.
In theory, with a lower interest rate, the Yen will be a less attractive
currency in the foreign exchange market. When one purchases some
Japanese Yen, he will need to pay to keep and store the money. It would be
more rational to purchase some other currencies with higher returns. The
demand for Yen should decrease, and its value should depreciate.
However, in reality, we can see that the Yen appreciates. We should
note that the y-axis is the number of US dollars per Japanese yen. A lower
level means that one yen is worth more dollars. In other words, the general
trend is that yen is appreciating. Obviously the intended results of controlling
the yens appreciation is not reached. The policy is apparently not effective.

Now we will try to explain this counter-intuitional phenomenon by


evaluating this policy. This policy does not work for mainly three reasons.
1. Inflation rate decreases from Feb. 2016
*Look at ppt July 2016 inflation rate and interest rate. Compare to October
2015.
Real interest rate actually increases.
Should see increase demand in Yen, and that should explain the
appreciation of Yen.
In other words, the policy is ineffective because the deflation problem
in Japan is not eliminated.

2. Japan Yen is typically recognized as a safe haven asset.


When the investors are uncertain about the stock market, they would
usually pull out their risky assets and purchase the safety assets such as gold
and the Japanese yen.
Dow Jones value is falling rapidly. Investors grew less confident. They
will then purchase the safety assets.
We do see that the price of a representative safety asset, namely, gold,
is rising. It is evidence for an increasing demand for the safety assets. If this
is indeed the case, the appreciation for the yen can also be explained since it
is also a safety asset.
In other words, this policy is ineffective due to the lack of confidence in
the stock markets.

3. Less carry trade


A carry trade is when investors borrow in a low-yielding currency to
fund investments in higher-yielding assets elsewhere. The yen was an ideal
currency for carry trades because of the low interest rates and the unlikely
chance of appreciating. Now with the appreciating trend, the yen grows less
popular for carry trade. That is to say less foreigners take out Japanese loans
and sell the yen on the foreign exchange market. The supply for yen on the
foreign market falls, and the exchange rate against the dollar appreciates.