Negative Real Interest Rates Weaken the Yen: The Structure Where Japan's Low Interest Rates Have Supported the U.S. Economy

1. The Issue of Real Interest Rates Behind the Yen’s Depreciation

Why is the Japanese yen weak?

Exchange rates cannot be explained simply by comparing the strength of the Japanese economy with that of the U.S. economy. One of the important factors is the difference in real interest rates.

Real interest rate refers to the interest rate after subtracting the expected inflation rate from the nominal interest rate. For example, if the interest rate on deposits or bonds is 1% and prices are expected to rise by 3% per year, the real interest rate is approximately negative 2%.

In this state, even if you hold money in yen, your purchasing power may decrease.

Of course, just because the real interest rate is negative does not necessarily mean the yen will weaken. Exchange rates are also influenced by the nominal interest rate differential between Japan and the U.S., future monetary policy, the current account balance, confidence in fiscal policy, and investor risk appetite.

However, if the state of low real interest rates continues for a long time and overseas interest rates are relatively high, the incentive for investors to borrow yen and invest it overseas becomes stronger than holding yen.

This is an important structure to consider when thinking about the weakness of the Japanese yen.

2. What is the Yen Carry Trade?

The yen carry trade is a transaction in which low-interest yen is borrowed, the funds are exchanged for dollars or other currencies, and then invested in assets that are expected to yield higher returns.

For example, an investor borrows yen at a low interest rate, exchanges that yen for dollars, and purchases U.S. Treasury bonds or U.S. stocks.

For the investor, the difference between the borrowing cost and the investment yield becomes a profit opportunity.

Of course, there is also the possibility of losses occurring due to exchange rate fluctuations. If the yen appreciates rapidly, losses can swell when selling overseas assets to buy back yen.

Even so, if Japanese interest rates remain low for a long period and the interest rate differential with overseas remains large, the yen becomes easily used as a “funding currency” in global financial markets.

While Japan’s low interest rates are a policy to support domestic companies and households, they have also become a means for overseas investors to raise funds at a low cost.

3. Japan’s Low Interest Rates Have Contributed to Supporting the U.S. Economy

What I would like to consider here is the point that Japan’s monetary policy is not completed solely within Japan.

If the movement to raise low-interest funds in Japan and invest in U.S. stocks and bonds spreads, funds will flow into the U.S. financial market.

As a result, the following effects can occur in the U.S.

First, it supports the U.S. stock market.

If investors who have borrowed yen purchase U.S. stocks, demand for equities increases. All else being equal, this acts to support stock prices.

Second, it supports the U.S. bond market.

If demand for U.S. Treasuries and other bonds increases, it can push up bond prices and act to lower yields. This can also have an indirect impact on corporate financing environments.

Third, it eases financial conditions.

When investment using low-cost funds becomes active, U.S. financial conditions can become accommodative through credit supply and asset prices.

In fact, the Bank for International Settlements (BIS) analyzed the spillover of financial conditions from Japan to the U.S. in its 2025 Annual Economic Report, pointing out that transactions using the yen as a funding currency were one factor that eased U.S. financial conditions.

In other words, Japan’s low interest rates have influenced not only the financial environment within Japan but also global financial markets, including those of the United States.

However, the growth of the U.S. economy cannot be explained solely by the yen carry trade. U.S. technological innovation, corporate earnings, consumption, fiscal policy, and monetary policy are also important.

Nevertheless, the perspective that Japan’s low interest rates have supported overseas asset demand is essential for understanding international finance.

4. Japan supplies capital, and the U.S. utilizes it

I would like to consider this structure from a slightly broader perspective.

Japan has a large amount of financial assets held by households and financial institutions. On the other hand, the U.S. has stock markets, bond markets, corporate groups, and a technological development environment that attract capital from around the world.

If low-cost funds can be raised in Japan, a portion of them will head toward overseas markets, starting with the United States.

The fact that Japanese investors earn returns from overseas assets is not in itself a bad thing. Overseas investment can sometimes benefit Japanese households and pension funds.

The problem is that the appeal and profit opportunities for utilizing capital within Japan are not sufficiently developed, causing the flow of funds generated by low interest rates to become skewed toward overseas markets.

While investment to increase productivity within the country is lacking and real wages remain stagnant, funds flowing from Japan support demand for stocks and bonds overseas.

If this structure continues, even if Japan holds overseas assets, it may not be able to sufficiently link those funds to domestic wage increases or the cultivation of new industries.

Of course, returns from overseas investments also flow back to Japan through dividends and interest. However, managing assets overseas is not the same as increasing employment, productivity, and real wages within Japan.

How to connect the fruits of asset management to domestic prosperity—that is Japan’s challenge.

5. Those who benefit from a weak yen and those who bear the burden

A weaker yen has the effect of boosting the overseas earnings of export companies when converted into yen. For investors holding foreign assets, the yen-denominated valuation may also increase.

On the other hand, the prices of imported energy, food, raw materials, and the like tend to rise due to a weaker yen.

If companies pass on the rise in import costs to sales prices, the burden on households increases. If wage growth does not keep pace with price increases, real wages will decline.

In other words, a weaker yen does not bring benefits equally to all citizens.

While it benefits those who hold foreign assets, it can create a burden of declining purchasing power for those whose primary income sources are yen-denominated deposits or salaries.

That is why the exchange rate should not be evaluated solely by the profits of export companies. What is important is how the real income and standard of living of the people change.

6. Measures against a weak yen cannot be solved by currency intervention alone

When the yen weakens, currency intervention by the government attracts attention.

However, while currency intervention can be a means to curb rapid fluctuations in the market, it does not permanently resolve fundamental factors such as interest rate differentials or the profitability of domestic investment.

What is needed is to change the structure of the Japanese economy itself.

1. Normalize the relationship between real interest rates and monetary policy

If nominal interest rates are too low while price increases continue, real interest rates tend to become negative.

However, if rapid interest rate hikes are implemented to raise real interest rates, it will affect mortgages, corporate borrowing, and interest payments on government bonds. Monetary policy must be advanced cautiously while monitoring the stability of prices, wages, the economy, and the financial system.

The goal is not to raise interest rates for the sake of it, but to stabilize the relationship between prices and interest rates and support confidence in the yen.

2. Create an environment where people want to invest domestically

Not only interest rate differentials, but also whether there are attractive investment destinations within the country is important.

If funds are directed toward fields that increase productivity, such as new technology, energy, medical care, nursing care, agriculture, logistics, and regional industries, new income and profit opportunities will be created domestically.

What is needed is not the withdrawal of funds from overseas itself. It is to increase attractive options for utilizing funds within the country as well.

3. Raise real wages

The foundation that supports confidence in the yen is not just monetary policy.

If the productivity of Japanese companies increases, wages rise sustainably, and household purchasing power improves, the fundamental strength of the domestic economy will grow.

To achieve this, it is necessary to combine capital investment, human resource development, labor mobility, improvement of the competitive environment, and the supply of funds to growth sectors.

4. Enhancing Trust in Fiscal Policy

The government’s medium- to long-term fiscal management also influences the valuation of the government bond market and the currency.

Clarifying expenditure priorities and increasing predictability for future fiscal management will be one of the factors supporting confidence in the yen.

7. When the Yen Carry Trade Reverses

The yen carry trade is not a permanent mechanism.

If Japanese interest rates rise or the yen appreciates, investors who have been borrowing yen to invest in overseas assets may reduce their positions.

In such a case, if investors sell U.S. stocks or bonds and buy back yen, it could lead to both yen appreciation and a decline in overseas assets simultaneously.

In August 2024, the unwinding of the yen carry trade led to significant volatility in global stock markets. The BIS also analyzed that the sudden contraction of transactions using the yen as a funding currency acted to tighten financial conditions in the United States.

This indicates that changes in Japan’s monetary policy can ripple through global financial markets.

Japan is no longer an entity isolated from global financial markets. Rather, the movements of Japanese interest rates and the yen have become important variables for global investors.

That is precisely why Japan’s monetary policy needs to be managed while considering not only domestic prices and the economy but also the spillover effects on international financial markets.

8. Thinking About How Japan Uses Its Funds from the Perspective of Circular Capitalism

I do not consider Japan’s challenge to be simply ‘stopping the yen’s depreciation.’

The essential challenge is to connect the funds existing within the country to a cycle that leads to the prosperity of the people.

Funds go toward investment, corporate productivity increases, employment and wages improve, and household disposable income rises. The increased income goes toward consumption and asset formation, which in turn generates further investment.

This is the basic concept of ‘Circular Capitalism’ that I advocate.

There is no need to deny overseas investment. On the contrary, earning returns from overseas is important.

However, a mechanism is needed to connect the profits earned overseas to new domestic industries, the regional economy, human resource development, and an increase in real wages.

Simply continuing to supply funds through low interest rates will not increase domestic growth potential. We must coordinate monetary policy, tax policy, industrial policy, and labor policy to design a system where funds circulate both domestically and internationally to generate national prosperity.

What Japan should aim for is not simply a stronger yen or higher interest rates.

It is to restore confidence in the yen, increase real wages, and create a cycle where Japanese capital nurtures Japan’s future.

If Japan’s low interest rates have been a factor supporting overseas financial markets, we must now consciously reshape the flow of funds to support domestic growth and the prosperity of our citizens.

The strength of the yen is not determined solely by exchange rate figures. How much value can the economy supporting that currency generate in the future? Answering that question is surely what will lead to the redesign of the Japanese economy.

Reference Materials

• Bank for International Settlements (BIS) ‘Annual Economic Report 2025’: Analysis of the spillover from Japan’s financial environment to the U.S. and the unwinding of the yen carry trade.Report (English)

Bank for International Settlements

+1

• International Monetary Fund (IMF) ‘Japan: 2026 Article IV Consultation’: Analysis of the relationship between Japan-U.S. interest rate differentials and the yen exchange rate, and the multiple factors affecting the yen.

elibrary.imf.org