When a currency’s value declines sharply, the direct solution may seem simple: the central bank or government intervenes in the foreign-exchange market and buys the domestic currency to increase demand for it and raise its value. But Japan’s latest experience raises a deeper economic question: Can a currency be protected through intervention alone, or does the problem fundamentally begin with interest rates?

This question emerged as Japan and the United States intervened in the currency market to support the yen, at a time when Japan’s intervention over a single month reached a record ¥15.4 trillion, or about $96.4 billion. Despite the enormous figure, attention quickly returned to monetary policy and the possibility of the Bank of Japan raising interest rates.

How Do Interest Rates Affect a Currency’s Value?

Interest rates do not determine only the cost of borrowing; they also influence the flow of money between economies.

When interest rates in one country are low compared with those in other countries, investors may find it less attractive to hold assets denominated in its currency, especially if they can earn higher returns in other markets. Conversely, higher interest rates can make bonds, deposits, and financial assets denominated in that currency more attractive, potentially increasing demand for it.

This is where the yen’s problem emerges: if returns on Japanese assets remain lower than those available in other economies, intervention in the foreign-exchange market may face a greater economic force in the form of interest-rate differentials.

Currency Intervention or a Change in Monetary Policy?

Intervention in the currency market can be compared to treating the symptom, while changing interest rates targets one of the causes driving capital flows.

When the government buys yen in the market, it creates additional demand for the currency and may push its value higher. But this effect may be limited if investors remain convinced that returns on Japanese assets are relatively low.

Raising interest rates, on the other hand, changes the equation from within the economy itself. It may narrow the gap between returns in Japan and those in other markets, thereby reducing the incentive to sell yen and move into higher-yielding currencies.

That is why the U.S. Treasury secretary urged the Bank of Japan to raise interest rates rather than repeatedly relying on intervention in the currency market.

Why Doesn’t Japan Simply Raise Interest Rates?

Because interest rates are not a tool designed solely for the currency market.

Higher interest rates may support the yen, but at the same time they raise borrowing costs for companies and households and affect investment, economic activity, and asset prices. For this reason, the central bank cannot set interest rates based solely on the currency’s value; it must balance inflation, growth, wages, and financial stability in its decision.

This is where the trade-off facing central banks emerges: The tool that helps solve a problem in one part of the economy may create pressures in another.

What Does the ¥15.4 Trillion Figure Tell Us?

The importance of this figure lies not only in its size, but also in what it reveals about the cost of directly defending a currency.

When a country needs to spend tens of billions of dollars in the foreign-exchange market, the most important question is no longer how much it can intervene, but rather: Are its monetary policies aligned with the direction in which it wants its currency to move?

If underlying market forces are pushing a currency lower, intervention may slow or temporarily reverse the movement, but on its own it cannot guarantee a change in direction over an extended period.

That is why the Bank of Japan’s September meeting became important for markets—not only because investors are awaiting a decision on interest rates, but also because the decision will signal how Japan wants to address the yen’s weakness: Will it continue to confront the market by buying the currency, or will it begin changing the economic conditions that are weighing on it?

Ultimately, currency movements are not determined solely by the amount of money used to defend them. Often, the more important figure behind an exchange rate is much smaller: the interest rate itself.