The Dollar-Yen Exchange Rate and the Monetary Model

This paper reexamines the empirical performance of monetary exchange rate models for the U.S. dollar-Japanese Yen exchange rate by allowing for temporal instability within different regimes. Special attention is paid to the question if interventions in the foreign exchange market coincide with structural breaks. Using monthly data from 1975:01 to 2008:12 and applying a novel time-varying coefficient estimation approach, we are able to show that macroeconomic fundamentals do matter for the U.S. dollar-Japanese Yen exchange rate, but in different ways during different time periods. Furthermore, our results suggest that there are no recurring regimes, i.e. across different regimes either the coefficient values for the same fundamentals differ or the significance differs. In addition, there is no regime in which no fundamentals enter. Last but not least, the deviations resulting from the stepwise cointegrating relationship act as a significant error-correction mechanism. The results with regard to the role of interventions are not clear-cut as periods of intervention do not necessarily result in structural breaks.