Seiji Adachi: Economic activity, prices, and monetary policy in Japan

Speech by Mr Seiji Adachi, Member of the Policy Board of the Bank of Japan, at a meeting with local leaders, Kumamoto, 29 May 2024.

The views expressed in this speech are those of the speaker and not the view of the BIS.

I. Recent Depreciation of the Yen and Monetary Policy

I usually start my speech at the meetings with local leaders by talking about developments in economic activity and prices. However, this time I would first like to talk about the Bank of Japan's possible responses to foreign exchange rate developments, while sharing my own views. This is because the Bank has been receiving an increasing number of opinions regarding its stance toward the weaker yen, which temporarily approached 160 yen against the U.S. dollar recently.

First of all, the basic principle is that the sole objective of monetary policy is to achieve price stability. The concept of the trilemma of international finance shows that no economy can simultaneously achieve the three goals of autonomous monetary policy, free capital mobility, and a stable foreign exchange rate. Based on this, if a central bank tries to fix the exchange rate, which fluctuates in the short term, at a certain level by means of monetary policy, this induces a trade-off for a large constraint on its future conduct of monetary policy. Let me apply this idea to the current situation. If a central bank frequently changes its monetary policy to stabilize a foreign exchange rate that is as highly volatile as recently observed, swings in interest rates are expected to become larger. Should fluctuations in interest rates become too large, it will be difficult to project future interest rates, thereby hindering fund raising for households' housing investment and firms' fixed investment. If fund raising by firms and households becomes difficult, this inevitably has a negative impact on economic activity. I therefore believe that, if responses to short-term fluctuations in the foreign exchange rate are made by means of monetary policy, price stability will be adversely affected.