Lag structure between the balance of payments and the exchange rate under the floating exchange rate system : an empirical analysis on the yen vs. dollar exchange rate

Although, the Japanese foreign exchange rate system had maintained the fixed exchange rate system during its rapid growth period, it is already fifteen years since the ‘Nixson Crisis’ and the adaptation of the floating exchange rate system. Before its introduction, the floating exchange rate system was considered as an ideal exchange rate system, and had strong support from various economists. However, once floating exchange rate system was introduced, it was realized that although the exchange rate itself moved more than expected, the system does not have the power to adjust the balance of payments, at least in the short-run. In this paper, we shall evaluate the relations between the yen vs. dollar exchange rate and balance of payments in Japan under the floating exchange rate system. There is an interrelation between the exchange rate and the balance of payments, but to evaluate the effect of changing exchange rate on the balance of payments, we need a complete macro-econometric model. So, we leave which problem for another paper. This paper is organized as follows: After a brief introduction in section 1, we shall graphically review relations between the exchange rate and various measures of balance of payments, in section 2. In section 3, we shall consider the lagged correlation between the yen vs. dollar exchange rate and the balance of payments. In section 4, we shall present estimated results on the yen vs. dollar exchange rate by various distributed-lag models of the balance of payments. Finally, in section 5, we shall summarize our conclusions and state possible extentions for the future