The recent sharp yen appreciation against US dollar, euro and other currencies, including those of emerging Asian economies, has considerably weakened Japan's international price competitiveness.

In his most recent speech, Donald Kohn, Fed Vice Chairman, said that the Fed has learned that the aftermath of a bubble can be far more painful than it imagined. He then carefully examined alternative strategies for monetary policy to deal with asset price bubbles. However, he did not specifically discuss a potential role of foreign exchange rates in the aftermath of a bubble in supporting aggregate demand through their influence on exports.

In fact, a number of OECD countries, which suffered from domestic asset market declines in the late 1980s or early 1990s, experienced large currency depreciations as a result of a loss of market confidence in their economies. The resulting strengthening of international price competitiveness led to a sharp upturn in exports and helped the recovery of overall output activity.

In contrast, the Japanese yen followed an uptrend even after the burst of the bubble in the early 1990s. Between end-1990 and April 1995, the yen appreciated against a basket of currencies of its trade partner countries by 64%. As a result, Japanese export volumes either declined or grew at a pace far below the growth of its markets each year, leading to a sharp decline in Japan's share in the world export market. Thus, net exports made a negative contribution to GDP growth. Nevertheless, Japan somehow maintained a positive GDP growth, with fiscal and monetary support to domestic demand growth.

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