The parameters of a conventional model of Japan’s current account were found to be stable in the period of the steeply rising yen between the fourth quarter of 1985 and the end of 1987. This suggests that Japan’s current account has been adjusting to the strengthening yen in accordance with established historical relationships—a conclusion that is substantiated by the model’s reasonably accurate tracking of the current account in this period. Furthermore, simulations of the model show that the rise in the yen has already made a substantial contribution to correcting Japan’s external imbalance.

The factors that explain Japan’s external performance since the mid-1980s are controversial. While the current account surplus eventually declined following exchange rate changes in 1985-86, a widening since 1990 has led to renewed scepticism about the role of relative price movements in bringing about external adjustment. This paper revisits the post-1985 experience to determine whether it can be explained by traditional factors. The results indicate that, over the period as a whole, the behavior of trade volumes and prices was similar to that predicted by traditional relationships. In particular, relative price movements played an important role in reducing the surplus: in their absence, it would have widened further.

This paper presents a quantitative evaluation of the effect on the yen of some alternative scenarios under which Japan reaches current account balance. The analytical framework is a global general-equilibrium model, based closely on Obstfeld and Rogoff (2005a, 2005b), within which relative prices clear the world markets for traded goods as well as the domestic markets for nontraded goods. Depending on assumptions about the critical substitution elasticities underlying the model, the yen could appreciate by as much as 10 per cent for each 1 percent of GDP reduction in its current account surplus. The effect would be smaller if substitution elasticities are larger, or if adjustment is accompanied by an expansion of Japanese nontradable output, the latter presumably implied by a return to a more efficient level of labor utilization.--Author's desription.

During risk-off episodes, the yen is a safe haven currency and on average appreciates against the U.S. dollar. We investigate the proximate causes of yen risk-off appreciations. We find that neither capital inflows nor expectations of the future monetary policy stance can explain the yen’s safe haven behavior. In contrast, we find evidence that changes in market participants’ risk perceptions trigger derivatives trading, which in turn lead to changes in the spot exchange rate without capital flows. Specifically, we find that risk-off episodes coincide with forward hedging and reduced net short positions or a buildup of net long positions in yen. These empirical findings suggest that offshore and complex financial transactions should be part of spillover analyses and that the effectiveness of capital flow management measures or monetary policy coordination to address excessive exchange rate volatility might be limited in certain cases.