A Vector Error Correction Model for Japanese Real Exports

Abstract

Japanese exports did not immediately react to the depreciations of the yen after a change in the economic policy framework in 2012, with the launching of Abenomics. This article focuses on the Japanese foreign sector and investigates the extent to which exchange rate changes affect Japanese real exports. After studying the dynamic properties of the included time series variables, a vector error correction model was estimated for the period 1980–2016 based on trade data from the World Bank and the International Monetary Fund. This study investigated the dynamic causal relationships among real exports, external demand, price competitiveness, and real imports. Within a large body of literature on Japanese exports, most extant studies used the trade balance as the dependent variable. One novelty of this study is the estimation of a quatrovariate system in which the components of trade balance, namely real exports and real imports, are both endogenously determined. A unique long-run cointegration equation was identified in which the external demand for exports, as proxied by gross domestic product of the rest of the world combined, has the most significant impact on real exports. The elasticity of real exports with respect to the real exchange rate was 2.34. However, the speed of adjustment towards long-run equilibrium was about 9% per year, which was rather slow. The low speed of adjustment implies it would take approximately 10 years for the full adjustment to take place and, thus, provides a novel explanation as to why the yen’s depreciation, triggered by Abenomics, did not boost Japanese exports as was expected by the Japanese government.