If dollar deposits pay more interest than yen deposits, more people may want to sell yen and buy dollars.Other things equal, higher-yielding currencies tend to attract demand.This is the starting point for explaining how Japan–U.S. rate differentials weaken the yen.

Suppose yen investments pay 1% annually and dollars 4%. Excluding taxes and fees and with unchanged exchange rates, dollars outperform. But if the dollar falls before conversion back to yen, losses may exceed the interest advantage. These rates are illustrative.

Rates matter but do not determine exchange rates alone. Expected future rates and currencies matter too. Even at unchanged exchange rates, higher foreign prices reduce what yen can buy abroad. Let us examine rates, prices, and Japan's overseas earnings in turn.

Demand for higher-yielding dollars can weaken the yen

More yen selling to buy dollars pressures the yen lower. But anticipated higher rates may already be priced in. A U.S. rate hike does not guarantee subsequent dollar appreciation; changes relative to expectations matter.

Wataru Miyamoto's research estimates that U.S. rate changes explain a large share of USD/JPY movements from early 2021 through September 2023, while finding less explanatory power in other periods. These are the author's model-based estimates under assumptions, not the Bank of Japan's official view. They support rates as an important factor, not a universal forecasting formula. Wataru Miyamoto, An Analysis of Trends and Determinants of Japan's Exchange Rate should be read together with its limitations.

Indeed, the IMF's 2026 Japan review notes yen depreciation since mid-2025 despite a narrowing long-term Japan–U.S. rate differential. Paragraph 16 of that report is a concrete counterexample to the claim that narrowing differentials always strengthen the yen. Consider changes in inflation and monetary-policy expectations as well as rates.

Separate the exchange price from purchasing power abroad

JPY150 per dollar is the price of exchanging yen and dollars—the nominal exchange rate. Japan trades with more than the United States. The nominal effective exchange rate combines several currencies, weighting major trading partners more heavily.

The real effective exchange rate also adjusts for relative prices in Japan and abroad. Even with unchanged currency conversion, higher foreign goods prices reduce overseas purchasing power. The index captures relative price changes, but does not directly measure an individual's travel costs. The Bank of Japan's explanation and BIS definitions provide the basis.

Both chart lines indicate yen depreciation when they fall. Each is indexed to 2020 = 100; 100 is not an economically fair-value benchmark.

Averaging monthly 2000 values gives 103.9 nominal and 162.1 real; both equal 100 in 2020. Thus, modest nominal decline over those 20 years coincided with substantial real decline. Nominal depreciation followed, with July 2026 values of 67.57 nominal and 65.04 real. Long-standing relative-price differences combine with recent currency depreciation. Figures use the Bank of Japan's published monthly values, with annual averages calculated as simple means of 12 months.

Why do interest rates rise when prices rise?

At 3% annual interest and 2% inflation, purchasing power grows by roughly 1%. The inflation-adjusted return is the real interest rate. An approximate relationship incorporating expected future inflation isNominal interest rate ≈ Real interest rate + Expected inflation—the Fisher relation. Expected inflation is anticipated price growth. At an unchanged real rate, higher expected inflation requires higher nominal interest as compensation. This is approximate, and bond yields also include premiums for inflation uncertainty and other factors. D’Amico・Kim・Wei「Tips from TIPS」 also addresses this. Higher nominal rates do not necessarily mean higher real rates if expected inflation rises equally.

Another reason rates and prices rise together is that central banks may raise rates to restrain demand-driven inflation. In turn, higher borrowing costs can dampen consumption and investment and reduce inflation over time. The Federal Reserve's policy explanation describes this two-way relationship.

Therefore, rates and prices rising together does not establish that rate increases caused inflation. Romer・Romer「A New Measure of Monetary Shocks: Derivation and Implications」 analyzes U.S. data for 1969–1996 using a method removing policy responses to economic and inflation forecasts, estimating that tightening reduces later inflation. Such analysis distinguishes co-movement from causation.

Overseas profits do not necessarily create immediate yen demand

Has Japan lost its ability to earn abroad? Goods trade misses dividends and interest from overseas investments. Ministry of Finance statistics show a JPY32.2 trillion current-account surplus in 2025. The current account combines goods and services transactions with investment income and other flows.

Source: Ministry of Finance: Trends in the Balance of Payments, calendar-year summary. Revised published figures retrieved September 7, 2026 are rounded to trillions of yen.

Tax rules also affect repatriation decisions. Introduced in 2009, the foreign subsidiary dividend exemption generally excludes 95% of dividends from a foreign subsidiary held at least 25% for at least 6 continuous months from the Japanese parent's taxable income. Treaty exceptions may alter ownership requirements, and dividends from profits already taxed under CFC rules have separate adjustments.

There is empirical support for the view that the reform encouraged repatriation. Hasegawa・Kakebayashi「The effect of foreign dividend exemption on profit repatriation through dividends, royalties, and interest: evidence from Japan」 estimates that the 2009 tax reduction increased dividends and total remittances to Japanese parents, using the author's statistical model and company data from 2004 and 2007–2013.

However, this rule alone cannot explain Japan's income surplus. Primary income includes not only dividends and interest but some profits retained abroad. Under the Bank of Japan's statistical treatment, the parent's share of retained affiliate earnings is recorded as primary income and an equal reinvestment in the financial account.Encouraging repatriation differs from increasing total primary income.

Moreover, dividends retained or invested in foreign currency create no immediate yen purchase. Balance-of-payments statistics do not directly measure currency conversions, so an income surplus can coexist with yen weakness. This research also does not establish how much tax-driven repatriation moved exchange rates.

The digital deficit alone cannot explain the scale of yen depreciation

Payments for foreign cloud, software, and advertising services are another issue. A BOJ Review identifies computer services, intellectual-property charges, and professional and management consulting as major digital-related categories, with payments increasingly exceeding receipts. However, the statistical definitions include legal, accounting, and management consulting in the last category. The “digital deficit” is therefore not identical to a directly isolated measure of digital services alone. The BOJ Review, Globalization of Service Transactions as Seen in Balance of Payments Statistics requires care on this classification point.

Rising payments may increase foreign-currency demand. But they cannot be declared the main cause of depreciation without examining overall trade, investment, payment currencies, and hedging. Foreign services may also improve domestic productivity, so higher payments do not automatically mean an equal increase in economic loss.

Long-term real yen depreciation involves prices and productivity

With unchanged nominal exchange rates and faster foreign inflation, Japanese prices become relatively lower in a common currency. The real effective index reflects this. It adjusts for observed relative prices, distinct from expected inflation used in interest-rate analysis.This does not prove that low inflation caused nominal yen depreciation.

Purchasing-power parity suggests exchange rates adjust toward equal prices for identical goods after conversion. If strictly valid in the long run, a lower-inflation country's currency would appreciate nominally and offset price differences. Persistent real depreciation shows that offset was incomplete. As the IMF explains, transport costs, nontradable services, and consumption differences make a unique fair USD/JPY rate difficult to derive from prices alone. The BIS also explains that an index below 100 does not itself establish undervaluation.。

Productivity is one possible background factor. Yoshihiko Hogen and Naoya Kishi use a Japan–U.S. model separating tradable and nontradable sectors and suggest that Japan's relative decline in tradable-sector productivity contributed to real depreciation since the mid-1990s. Weaker relative earning-power growth may reduce upward pressure on wages and domestic service prices. This differs from claiming an absolute productivity decline. Yoshihiko Hogen and Naoya Kishi, On the Balassa–Samuelson Effect in Japan is also a bilateral model estimate, not the BOJ's official view. It alone cannot explain the entire effective-rate movement against multiple currencies or sharp moves over months.

Whose problem is yen weakness, and in what sense?

It is reasonable to emphasize rates and expectations for 2021–2023 nominal depreciation, while also examining relative prices and productivity for long-term real depreciation. A current-account surplus guarantees no appreciation, and neither digital deficits nor productivity determine daily rates alone. If yen weakness persists after rate expectations change, examine capital flows and currency-risk pricing rather than repeat the same explanation.

Gains and losses from depreciation depend on income and cost currencies. Foreign-currency revenue with yen costs may benefit, while import-dependent firms unable to raise prices suffer. Prices, volumes, and hedges modify both outcomes. Households face whether wage and income growth offsets import inflation.

Yen depreciation does not prove everything in Japan has weakened. Start with demand for higher-yielding dollars, then consider price differences and use of overseas profits. This helps interpret depreciation beyond rate differentials alone.