Purchasing power parity: Granger causality tests for the yen–dollar exchange rate

Abstract

The paper analyses the causality between the Japanese prices and the yen–dollar exchange rate. It explains the long-term appreciation trend of the Japanese yen and why the Japanese yen proved strong even during the economic slump of the 1990s. The paper suggests that the appreciation of the Japanese yen forced the Japanese enterprises into price reductions and productivity increases, which put a floor under the high level of the yen and, thus, initiated rounds of appreciation. This corresponds to the conjecture of a vicious (virtuous) circle of appreciation and price adaptation. Further, there is evidence that the yen-appreciation has been accommodated by the Bank of Japan’s monetary policy. This corresponds to the conjecture that the recent Japanese deflation is imposed from outside via the exchange rate.