Exchange Rates and Foreign Trade - An Example Involving Japan and the USA

The aim of this paper is to challenge the widely made claim that a weaker currency will automatically improve the current-account balance. Its objective is to present the puzzling fact that, for an open economy, a current-account reaction to nominal exchange rate changes cannot be identified. American politicians often use this incorrect interpretation as part of a protectionist-trade strategy to force the Japanese yen higher, the author claims. Two simple models accompanied by empirical evidence are presented to illustrate the effect of such a faulty notion. The results indicate that enormous fluctuations of the yen exchange rate led the Bank of Japan to adjust its monetary policy, which have pushed the yen into its present (at the writing of this paper) deflationary spiral.