APPLYING ECONOMIC MODELS TO INTERPRET THE EXCHANGE RATE MOVEMENT OF THE JAPANESE YEN TO THE AMERICAN DOLLAR

This paper will discuss the exchange rate movement of the Japanese Yen to the American dollar using three popular exchange rate models: 1) the Purchasing Power Parity (PPP); 2) the Current Account Model (CAM); and 3) the Portfolio Balance Model (PBM). These three models will be discussed after a brief introduction that will establish the groundwork for the investigation.

Historical Evaluation of the Yen/Dollar Relationship

Hedging and arbitrage to achieve exchange rate maximization are primarily functions of capitalistic economies. Since both the United States and Japan are "capitalist" countries (although each adheres to a different philosophy of capitalism) a study of the relationship between the Japanese Yen and the American Dollar can be an instructive guide to the disparate nature of capitalism. The American government still adheres to the myth of free market fluctuations and flexibility as the basis of capitalism, while the Japanese believe that business and government must become allies to engender growth of Japanese companies.

World currency exchange trade is competitive and volatile, growing even more so with the trend toward computer analysis and the growing web of global networking, two trends, which have made currency ratios change on a minute-to-minute basis. "Trying to keep score in the continuing Asian financial crisis? Here's an early call:

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ty is basically the belief that there can be applied the law of one price for goods and services of equal value across borders and markets. At the root of PPP is the caveat that there must be no government intervention and that significant freight charges and tariffs must be harmonized. Given those elements, internationally traded goods should generate the same effective revenues when converted into the same currency. This theory was the basis of all of the Bretton-Woods agreements, and belongs to that simpler time. Ramirez and Khan (1999) address this problem in their cointegration analysis. "Today the world is characterized by a number of complications such as differentiated products, tastes, and costly information. These have created considerable problems for economists testing the [PPP] theory empirically in the post-Bretton Woods era" (Ramirez & Khan, 1999, 371). Judging from the volatility of the exchange movement during the period shown in Table 1, the conclusion is that the PPP model is ineffective for evaluating the movement, specifically because of the relationship between the Japanese government and businesses, one which artificially supports the Yen without the benefit of a sound monetary policy. The CAB Mod

Category: Economics - A