TERMS OF TRADE, REAL INTEREST RATE DIFFERENTIAL AND REAL EXCHANGE RATE IN JAPAN: AN EMPIRICAL STUDY

Abstract

This study examines the real exchange rate determination in Japan. The results of the long-run cointegrating vectors show that an increase in the real oil price will lead to a depreciation of the real exchange rate whilst an increase in productivity differential will lead to an appreciation of the real exchange rate. The results of the error correction models show that the real oil price, productivity differential, and the real interest rate differential are important in the real exchange rate determination. The results of the generalized forecast error variance decompositions show that productivity differential is relatively more important than the real oil price in the real exchange rate determination. Generally, the real oil price, productivity differential, and the real interest rate differential are important in the real exchange rate determination in Japan.