The exchange rate and Foreign exchange reserves : Japan and United States, 1974 to 2010

Abstract

The exchange rate is very difficult to predict. In 1971, the fixed exchange rate system transferred to a floating exchange rate system after the collapse of the Bretton Woods System. The Bretton Woods system established the principle for commercial and financial transactions among the major industrial countries after World War II. Japan, United States, and Germany are the major three influential countries in international commerce. The Japanese yen, US dollar, and German mark are the major currencies in the exchange rate market. In a floating exchange rate regime, the exchange rate may reflect the financial situation of countries. Central banks might allow one currency price to float freely between upper and lower bond. Central banks can buy or sell foreign exchange against their currency to affect the exchange rate. This is called official intervention. This thesis examines two major currencies, Japanese yen and the US dollars, in an exchange rate model depending on international trade, central bank foreign exchange reserves, and interest rates. Unit root tests for stationarity and Bayesian information criterion (BIC) are used in this thesis. Finally a lagged transformation model tests the short term and long term adjustments.