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In September 1985, Japan, the US, and three other nations agreed to the "Plaza Accord," which appreciated the Yen and Deutsche Mark. The value of the Japanese Yen appreciated from 200 Yen per Dollar to 100 Yen per Dollar.
How was this implemented? What of the free market? Did interest rates in Japan double? What are the mechanics by which an external intervention like this is made to hold in the "free" market (especially the FX market which is renowned for being so liquid and so "free").
Thanks
The Plaza Accord was implemented through market mechanisms. According to Wikipedia Central banks of the signatory nations spent $10 billion dollars. They exchanged these dollars for other currencies. This increases the supply of dollars and may even decrease demand if so far the central banks have been purchasing dollars. Due to the higher supply and not higher demand the 'price' or exchange rate of the dollar fell. At the same time the countries also implemented policy changes. This would effect the mid to long term exchange rates.
The Japanese interest rate did indeed fall.
http://www.tradingeconomics.com/japan/interest-rate
Mind though that the US interest rate also fell
http://www.tradingeconomics.com/united-states/interest-rate
Let JGOV mean the Japanese Government. I base my answer on my B.A. in Economics and this Reddit post.
With the Plaza Accord, the US forced Japan to fix the trade deficit by rapidly appreciating the Yen that hurt Japanese exports. The Bank of Japan tried to compensate by lowering interest rates to near 0% which didn't boost consumption/investment, but instead lead to speculative borrowing and huge bubble.
The issue wasn't just the Plaza Accord. The main thing that ultimately caused the lost decades was a combination of the Plaza Accord, the JGOV's incompetent mindset (thinking that we can do no wrong), the ill-fashioned stimulus plan and a combination of other factors.
The first thing that happened was the Plaza Accord. The US was getting worried about potential Japanese power supplanting American hegemony just like China is today, and just like today there were articles ALL over the news about the Japanese "stealing US jobs" and "trade-cheating" (quite odd how similar that is to today!). The Japanese kept stalling and stalling trying to bide for time by painting (quite successfully actually because of Japan's reputation of being a democracy) the American politicians and policymakers of being racist and anti-Japan. While Japanese's scheme worked for a while, the fundamental game of geopolitics prevailed and the US used its political capital to force the Plaza Accord on the Japanese.
This appreciated the Yen. Normally for an export-driven economy, you want your currency undervalued because that cheapens your exports. Japan's appreciated Yen made it to lose exports and this loss caused panic. Exports were going to drop and aggregate demand was going to collapse.
The most important thing is that the Japanese economy was already well developed. Japan couldn't invest more into infrastructure because of the law of diminishing returns (where investing more leads to less and less marginal returns). In fact Japan caught up in terms of productivity to the West in the 80's. This meant that stimulus was a terrible choice! The JGOV should've simply manned up and faced the recession. Instead, the JGOV decided to lower interest rates (therefore boosting investment) and invest in infrastructure (boosting government spending). This led to credit and investment money flowing into speculative bubbles across the economy, which tied up a lot of companies' assets. When they burst, they burst the huge exposures they had led to a ripple effect which led to...
...the second major policy error! Instead of rolling back stimulus and investment after the bubble burst, the JGOV kept pumping money into the economy to keep a prolonged dip in employment from occurring, because the JGOV continued to lend to insolvent companies, and to restructure the huge debt into government debt. The ripple effects from these two major policy blunders led to the Japan's lost decades.
The notion of "sticking together" and "helping each other out" is very strong. The 2012 earthquake instantiated this, where people weren't looting but were calm and supportive throughout the entire country. Another factor the Japanese work culture of "life in a company", where a worker joins a company directly after study or training and stays with this company for their entire life. Both factors make it difficult for politicians to face up to the problem and end several of these lifelong "bonds", by letting several companies go bankrupt and therefore a wave of people get unemployed.
Because of the group culture, direct criticism is a no-go in Japan. Simply speaking, there isn't a culture of harsh criticism and social protest (this changed a bit recently but not very much). Thus the Japanese political parties don't have to face backlash for bad politics, as few are interested in the work of politics.
