A dynamic econometric system for the real yen–dollar rate

This paper investigates the existence of theory-consistent cointegrating relationships between the real yen–dollar exchange rate and economic fundamentals in Japan and the US. After rigorous cointegration analysis, the paper constructs a data-congruent simultaneous equations system for the real yen–dollar rate. Multivariate cointegration analysis covering the post-Bretton Woods period reveals two long-run relationships which are consistent with macroeconomic theories: one is based on a condition of uncovered interest rate parity incorporating the Japanese current account balance, and the other on a structural balance-of-payments equation. Several topics in time series econometrics such as exogeneity are also discussed in the model construction. Finally, a parsimonious dynamic system centering on the real yen–dollar rate is presented as a set of equilibrium correction models conditional on weakly exogenous variables.