NEW HAVEN, Connecticut – On a recent visit to Sapporo, the city on Japan’s northern island where my parents came from, my wife and I found gentle people, mild autumn days and excellent food. As tourists who live and work in the United States, we also enjoyed very low prices: lunch at a high-quality restaurant cost only about $20 per person. While that was convenient for us, like so many other tourists who have headed to Japan to take advantage of favorable exchange rates, the cheap yen has been hard on Japan’s economy.
To understand the pressure Japan is under, it is worth looking at the purchasing-power-parity equilibrium exchange rate — the rate at which a representative basket of goods and services would cost the same across two countries. This month, the OECD reports a PPP equilibrium exchange rate between Japan and the United States of around ¥93 per dollar. That is a far cry from the actual yen-dollar exchange rate, which has been hovering in the ¥150 to ¥160 range.
This means that goods produced in Japan cost much less than goods produced in the U.S. As a result, Japanese exporters enjoy high demand and strong profit margins, but importers are under severe pressure. The weak yen also hurts Japanese consumers, as it creates strong incentives to raise prices: With imported goods more expensive, domestic producers know that their output will find buyers and importers might pass their mounting costs on to buyers.