Modelling the real yen–dollar rate and inflation dynamics based on international parity conditions

Abstract This study aims to explore the dynamics of the real yen–dollar rate and inflation rates by analysing Japan–US monthly economic data in recent years. A real interest differential (RID) derived from international parity conditions plays a critical role in the empirical exploration. A multivariate analysis of the data reveals evidence which supports the RID hypothesis as a long-run economic relationship, distinct from the existing evidence in literature. The relationship also paves a way for the regime-switching analysis that explicitly allows for influences of the two countries’ monetary policies. The non-linear dynamic nature of the real yen–dollar rate is clarified in this analysis.