Long swings in Japan’s current account and in the yen
The yen has experienced several big swings over recent decades. This paper argues that the fluctuations of the Japanese exchange rate resulted mainly from corresponding movements in the current account, which affected the demand for yen relative to other currencies. The paper builds a vector error correction model for the exchange rate and the current account, based on the idea that the exchange rate and its economic fundamental do not move too far apart over time. In addition, the model allows for a Markov-switching stochastic trend in the current account. Regime changes occur at uncertain dates, possibly in response to exchange rate changes. Bayesian estimation proceeds using an innovative Gibbs-sampling procedure. The empirical results suggest that recurrent structural breaks in the yen’s fundamentals account for the large fluctuations of the Japanese exchange rate.
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