In mid-December, the Japanese yen began another bout of weakening against the dollar. In analyzing exchange rate movements, one important concept is uncovered interest rate parity (UIP), by which the movement in the exchange rate expected by the market must equal the interest rate differential between the two countries. While U.S. short-term interest rates have continued to decline, Japan’s short-term interest rates have shown little movement since mid-2001. In this case, UIP would imply that the market now must expect a smaller movement in the yen-to-dollar exchange rate. Many studies, however, have failed to provide evidence that supports the UIP concept. One possible explanation for this contradiction lies in the movement of risk premiums.
Suggested citation: "Japan’s Economy," Federal Reserve Bank of Cleveland, Economic Trends, no. 02-01, pp. 08, 01.01.2002.