Analyze Foreign Exchange and Investment and the Effects EachNation’s Economy Has on Another Nation’s Economy

Introduction:
In an increasingly globalized world, foreign exchange (FX) markets play a pivotal role infacilitating trade, investment, and economic interdependence among nations. The U.S. dollar (USD)–Japanese yen (JPY) currency pair is one of the most actively traded in the world, reflecting thesignificance of both economies on the global stage (Mishkin & Eakins, 2018). Over the past fiveyears (2020–2024), the USD–JPY rate has experienced notable fluctuations driven by divergingmonetary policies, inflation differentials, and shifts in capital flows. This paper examines thosefive‐year exchange‐rate movements, explains the underlying economic factors including monetarypolicy, inflation, and capital flows applies key international finance theories (Interest Rate Parity andthe Fisher Effect), and evaluates how each nation’s economy influences the other. Ultimately, areasoned opinion is offered on which country has exerted greater influence on this exchange ratedynamic.
Five-Year Exchange Rate Data (USD–JPY)
Table 1
Average Annual USD–JPY Exchange Rates, 2020–2024
Year USD–JPY Average Rate2020 106.76
2021 109.83
2022 131.44
2023 140.95
2024 151.48
Source: Macrotrends LLC. (2025).
Factors Driving Exchange Rate Changes
Monetary Policy Divergence
Central bank policy rates are primary drivers of exchange‐rate movements. Following theglobal COVID‐19 shock, the U.S. Federal Reserve (Fed) maintained near‐zero policy rates through2021 before initiating aggressive rate hikes from March 2022 to combat escalating inflation (Boardof Governors of the Federal Reserve System, 2024). In contrast, the Bank of Japan (BoJ) persistedwith its ultra-loose monetary policy, negative interest rates and yield-curve control throughout 2020–2024 to stimulate domestic demand (Bank of Japan, 2024). The steep widening of the policy‐ratedifferential from near parity in 2020 to over 500 basis points by end of 2024 underlies the yen’sdepreciation against the dollar over this period (Mishkin & Eakins, 2018).
Inflation Differentials
Inflation differentials influence real interest rates and exchange values throughpurchasing‐power parity (PPP) mechanisms and real‐rate adjustments. In the United States, headlineConsumer Price Index (CPI) inflation surged from 1.4 percent year-on-year in January 2021 to apeak of 9.1 percent in June 2022, driven by energy and food shocks and robust post-pandemicdemand, forcing the Federal Reserve to embark on its fastest tightening cycle since the 1980s (U.S.Bureau of Labor Statistics, 2023). Core CPI, which strips out volatile food and energy, also climbedabove 5.5 percent, underscoring broad‐based price pressures and lifting nominal policy rates fromnear zero in early 2022 to 5.25 – 5.50 percent by December 2023. In contrast, Japan’s nationwideCPI inflation, while historically elevated for the BoJ, rose only from 0.0 percent in 2021 to about 3.2percent by October 2024, largely due to import‐driven energy costs rather than domestic overheating(Statistics Bureau of Japan, 2024).
As a result, U.S. real policy rates (nominal rate minus CPI inflation) shifted from deeplynegative territory in 2021 (around –3 percent) to mildly positive by late 2022, makingdollar‐denominated assets significantly more attractive on a risk‐adjusted basis. Meanwhile, Japan’sreal rates remained negative (around –1 percent) even as headline inflation ticked higher, because theBoJ kept its 0 percent short-term rate target and continued yield-curve control. Under relative PPP,this persistent gap in real returns implies an expected yen depreciation roughly in line with theinflation difference, on the order of 5–6 percent per year. In practice, the U.S.–Japan real interest
differential widened to over 600 basis points by late 2024, intensifying capital inflows into dollarassets and exerting sustained downward pressure on the yen.
Capital Flows and Safe‐Haven Dynamics
Capital flows react to risk sentiment, returns, and safe‐haven demand. In periods of globaluncertainty (e.g., early 2020 pandemic), both USD and JPY often appreciate due to safe-haven bids(Dominguez & Frankel, 2021). However, once U.S. rates rose sharply from 2022, the dollar attractedcarry‐trade positions, borrowing in low-yield yen to invest in high‐yield dollar assets, amplifying yenweakness (Burnside, Eichenbaum, & Rebelo, 2011). By contrast, Japanese investors increasedoverseas portfolio outflows to capture higher returns abroad, adding further downward pressure onthe yen.
Theoretical Frameworks
Interest Rate Parity (IRP)
Covered and uncovered interest‐rate parity (CIP and UIP) link currency forward discounts orpremiums to the interest‐rate gap between two countries. Under covered IRP, the forward-spotdifferential exactly offsets the on-shore interest differential so that arbitrage by borrowing in thelow‐rate currency and lending in the high‐rate currency yields zero profit once hedged. For example,in December 2024, U.S. 1-year rates averaged 5.0 percent, while Japan’s 1-year rates hovered at–0.1percent, implying a theoretical 1-year forward yen discount of roughly 5.1 percent (i.e., forward rate≈ spot × 1.051). However, actual 1-year USD–JPY forward contracts traded at discounts of 4.7–5.0percent, indicating small covered‐interest‐arbitrage cushions due to funding constraints andcounterparty risk in the FX swap market (Bank for International Settlements, 2023).
Under uncovered IRP, investors are willing to forgo the forward hedge and instead accept thespot‐rate risk, so the expected spot depreciation of the yen should approximate the interestdifferential. Empirically, from 2022 to 2024, the annualized dollar‐yen depreciation averaged about 7percent, versus an average nominal rate gap of over 5 percent, suggesting a modest risk premium of1–2 percent demanded by carry‐trade investors (Burnside, Eichenbaum, & Rebelo, 2011). Pressuresfrom Japan’s capital‐account regulations, such as limits on outward bond investments by retailinvestors, and global liquidity strains during spikes in risk‐off sentiment led to occasional CIPdeviations as large as 20 basis points, but these were largely transitory (Arai & Sasaki, 2022).
Fisher Effect
The Fisher Effect posits that nominal interest rates incorporate expected inflation. With U.S.inflation significantly above Japan’s, U.S. nominal rates rose correspondingly, exacerbating the ratedifferential. According to the Fisher relationship, a 1% increase in expected U.S. inflation shouldraise U.S. nominal rates by roughly 1%, thereby impacting FX returns and reinforcing the dollar’sstrength against the yen (Investopedia, 2024).
Economic Impacts on Japan and the U.S.
Japan
A weak yen makes Japanese exports more competitive in dollar terms, aiding Japan’sexport‐oriented economy by boosting revenues for major automotive and electronics exporters(Johnson, 2023). However, it raises import costs, particularly for energy and raw materials, exertinginflationary pressure on domestic consumers and eroding real incomes. The BoJ’s struggle to balancegrowth with imported inflation has been a central policy challenge.
United States
A strong dollar dampens U.S. export competitiveness but lowers import prices, benefitingconsumers with cheaper goods. It also attracts foreign investment into U.S. financial markets due tohigher returns on dollar assets, increasing capital inflows. However, multinational U.S. firms facecurrency translation losses when repatriating overseas earnings earned in depreciated foreigncurrencies.
Analysis and Opinion on Influence
Over the 2020–2024 period, monetary policy divergence emerges as the predominant driver.The Fed’s decisive tightening, contrasted with the BoJ’s stubborn accommodation, created anunprecedented policy‐rate gap (over 500 bps by late 2024), which IRP predicts would result insubstantial yen depreciation. While global risk sentiment and safe‐haven flows have intermittentlybuoyed the yen, these episodes were fleeting relative to the persistent trend.
In assessing which country exerted more influence, it is clear the U.S. Fed’s policy actions,and the underlying inflation environment, had the larger impact on USD–JPY movements. Japanesepolicy remained largely reactive, with the BoJ reluctant to adjust despite market pressures. The U.S.
economy’s stronger recovery from the pandemic and acute inflation surge compelled the Fed to act,setting the stage for the yen’s decline. Therefore, the U.S. economy, through its inflationarydynamics and consequent Fed policy, held greater sway over the USD–JPY exchange rate in thisfive‐year window.
Conclusion
Between January 2, 2020 (USD–JPY = 108.62) and December 31, 2024 (USD–JPY =151.48), the yen depreciated by roughly 39.5 percent against the dollar, an annualized decline near 8percent per year. This movement was propelled first and foremost by monetary policy divergence:the Federal Reserve raised its policy rate from 0–0.25 percent in early 2022 to 5.25–5.50 percent byDecember 2023, a cumulative hike of 525 basis points, while the Bank of Japan kept its short-termrate at –0.1 percent and maintained yield-curve control on 10-year JGBs near 0 percent.
Second, inflation and real‐rate dynamics amplified this gap. U.S. headline CPI reached 9.1percent in June 2022, shifting real U.S. policy rates from deeply negative to slightly positive,
whereas Japan’s CPI peaked at only 3.2 percent by October 2024, leaving real Japanese rates firmlynegative. This roughly 600-basis-point real-rate differential made dollar-denominated assets far moreattractive, underpinning sustained capital inflows into U.S. markets.
Third, carry-trade and capital-flow effects reinforced yen weakness. Investors borrowed yenat ultra-low rates and invested in higher-yield dollar instruments, putting continuous selling pressureon the yen. Although the JPY sporadically strengthened as a safe-haven during episodes like March2020 and October 2022, these were brief reversals compared to the persistent trend of yen carrytrades.
Applying uncovered interest-rate parity suggests that the expected annual depreciation(roughly equal to the interest-rate gap) of 5–6 percent was overshot, the yen declined closer to 8percent per year, implying a carry-trade risk premium of 1–2 percent. While a weaker yen boostedJapanese export revenues, it also raised import costs, complicating the BoJ’s stimulus objectives. Forthe U.S., a stronger dollar eased import prices for consumers but weighed on the foreign earnings ofmultinationals.
Ultimately, although both economies influenced each other via trade and capital channels, itwas the Fed’s aggressive tightening in response to U.S. inflation that decisively drove the USD–JPY
trajectory from 2020 to 2024. Therefore, U.S. monetary policy exerted the greater influence on thismajor currency pair during the period.
References

1. Bank of Japan. (2024). Monetary Policy Summary. Retrieved fromhttps://www.boj.or.jp/en/mopo/outline/index.htm
2. Board of Governors of the Federal Reserve System. (2024). Federal Reserve issues FOMCstatement. Retrieved from https://www.federalreserve.gov/newsevents
3. Burnside, C., Eichenbaum, M., & Rebelo, S. (2011). Carry trade and momentum in currencymarkets. Annual Review of Financial Economics, 3(1), 511–535.
   https://doi.org/10.1146/annurev-financial-102710-144723
4. Dominguez, K., & Frankel, J. (2021). Does foreign exchange intervention work?PetersonInstitute for International Economics.
5. Investopedia. (2024). Fisher Effect Definition. Retrieved fromhttps://www.investopedia.com/terms/f/fishereffect.asp