Japan’s monetary conundrum — why the yen hit a 40-year low as interest rates hit a 31-year high

It’s remarkable how often investors and policy makers focus on the wrong things and are misled. When it comes to monetary policy, obsessive attention is paid to interest rates. By doing so, observers are often wrong-footed. Indeed, monetary policy is all about changes in the money supply, not interest rates.

At present, this “barking up the wrong tree” phenomenon is occurring in Japan where, among other things, the yen just hit a 40-year low.

The widely held view on the Japanese economy over the past few years is that ultra-easy monetary policies, featuring near zero interest rates, have failed to boost spending and resulted in a plethora of economic problems for banks, savers and the government.

Governor Kazuo Ueda, who was appointed to lead the Bank of Japan (BOJ) in April 2023, ended “yield curve control” (YCC) in March 2024, and has been steadily raising its policy rate ever since. He has adopted the theory that wage increases plus higher energy and import prices will ensure sustained inflation and allow Japan to finally hit its inflation target of 2%. Under this theory, the Bank of Japan’s five interest rate hikes since then, from -0.1% to 1%, the highest since 1995, have been warranted. 

The problem with this widespread set of beliefs is that they are almost entirely........

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