Money Demand Instability and Real Exchange Rate Persistence in the Monetary Model of USD-JPY Exchange Rate

Abstract

This paper proposes a hybrid monetary model of the dollar-yen exchange rate that takes into account factors affecting the conventional monetary model’s building blocks. In particular, the hybrid monetary model is based on the incorporation of real stock prices to enhance money demand stability and also, productivity differential, relative government spending, and real oil price to explain real exchange rate persistence. By using quarterly data over a period of high international capital mobility and volatility (1980:01–2009:04), the results show that the proposed hybrid model provides a coherent long-run relation to explain the dollar-yen exchange rate as opposed to the conventional monetary model.

Keywords: Cointegration, Exchange rates, Monetary model, Weak exogeneity

JEL Classification: C22, F31, F36