Oil Price, Exchange Rate Shock, and the Japanese Economy

By using the framework of a structural vector autoregression (VAR) model, in this paper, we provide a quantitative assessment of the relative importance of exogenous shocks to Japanese output, as measured by aggregate sales, industry sales, and the sales of different firm-size groups. We analyze four structural shocks: (i) oil supply shock; (ii) oil price fluctuations not related to supply and demand; (iii) world economic activity (an aggregate demand shock); and (iv) exchange rate fluctuations not related to other structural shocks. We find that exogenous variation in oil production has little effect, whereas global economic conditions have a clear positive effect on output. The impact of the exchange rate depends on industry and firm size. Although appreciation of the yen has a negative impact on the Japanese economy as a whole, it has a clear positive effect on small and medium-sized enterprises in the nonmanufacturing sector. Our results suggest that recognizing the difference between fluctuations in the exchange rate and an exchange rate "shock" is important for macroeconomic policy management. In particular, much of the yen's appreciation following the Lehman Brothers collapse can be explained by the sudden slowdown in global real economic activity and the sharp decline in crude oil prices. Ignoring these factors greatly exaggerates the negative impact of the yen's appreciation on the Japanese economy.