Japan's Unconventional Monetary Policy and the Exchange Rate Dynamics

This paper empirically examines the response of the nominal exchange rate (U.S. dollar-yen exchange rate) to the monetary policy changes, focusing on the effects of various unconventional monetary policy measures implemented by the Bank of Japan over the past 25 years. Specifically, applying the estimation method proposed by Inoue and Rossi (2019), we identify Japan's "monetary policy shocks" from changes in the entire yield curve and the exchange rate around policy announcements, and estimate the dynamic response of the exchange rate to them. The results show that the yen depreciated against the U.S. dollar in many cases in response to Japan's expansionary monetary policy shocks, and that non-interest rate differential channel - e.g., the shifts in future exchange rate expectations - accounts for the larger parts of such responses than conventional interest rate differential channel. Moreover, our findings suggest that the responses of the exchange rate to unconventional monetary policies have been state-dependent in the sense that they could vary significantly depending on global financial market conditions and investors' herding behavior at each point in time.