Context: The Japanese yen experienced a sharp decline in value in 2022, which commentators attribute to global economic uncertainties and rising global commodity prices.
Introduction
The depreciation of a country's currency can be influenced by both demand-side and supply-side factors in the foreign exchange market. A depreciation occurs when the value of a currency falls relative to another, meaning more units of the depreciating currency are required to buy the same amount of foreign currency. In the case of the Japanese yen's significant depreciation in 2022, commentators have pointed to global economic uncertainties and rising global commodity prices as key contributing factors.
Demand-side factor: global economic uncertainty
One demand-side factor that can cause a currency to depreciate is global economic uncertainty. When uncertainties rise, such as during political instability, economic recession or geopolitical tensions, both consumers and firms become more cautious about spending and investing. This often reduces demand for exports from countries like Japan. Since foreign consumers and firms need to buy Japanese yen to purchase Japanese exports, a fall in demand for Japanese goods leads to a decline in the demand for the yen in the foreign exchange market. In addition, global uncertainties can discourage foreign investors from investing in Japanese assets such as stocks, bonds or real estate, which would typically require converting their home currency into yen. If foreign investors perceive greater risk, they may choose not to invest, further reducing demand for yen. This fall in demand shifts the demand curve for yen leftward, so the equilibrium price of the yen falls, leading to a depreciation.
Supply-side factor: rising global commodity prices
On the supply side, rising global commodity prices can also lead to depreciation. Commodities such as oil, natural gas and food are typically priced in foreign currencies such as the US dollar. When global commodity prices rise, countries like Japan, which are heavily reliant on imports for these essential goods, must spend more yen to purchase the same quantity of foreign goods. Because the demand for global commodities tends to be price inelastic, Japan cannot easily reduce its consumption of these essentials despite higher prices, so it must exchange more yen for foreign currencies to cover the increased cost. This increases the supply of yen in the foreign exchange market as Japanese firms and the government sell yen to buy foreign currencies. The increase in supply shifts the supply curve rightward, so the price of the yen falls, leading to a depreciation.
Conclusion
The depreciation of the Japanese yen in 2022 can be attributed to both demand-side and supply-side forces in the foreign exchange market. On the demand side, global economic uncertainty reduced foreign demand for Japanese exports and investments, lowering demand for the yen. On the supply side, rising global commodity prices increased Japan's import expenditure, prompting a higher outflow of yen to purchase foreign currencies. Together, these factors placed downward pressure on the yen's value, illustrating how external shocks and structural dependencies can significantly influence a country's exchange rate.