Dollar and Yen: The Problem of Financial Adjustment Between the United States and Japan

In this paper, I argue against using the exchange rate as an instrumental variable to "correct" current-account imbalances or equalize international competitiveness. From 1971, when a dollar was worth 360 yen, until July 1994, when it dipped to 98 yen, the efforts of the American government to "talk" or otherwise force the yen up and the dollar down have harmed both countries. While failing to correct trade imbalances, for reasons I will explain, continual yen appreciation has induced episodes of severe wageprice misalignments between the two countries, leading to unnecessary cyclical instability and losses in real output in the short run.