Interest Rate and Price Linkages between the USA and Japan: Evidence from the Post-Bretton Woods Period

Abstract

In this paper we investigate the extent to which a number of key parity conditions hold within and between the USA and Japan. Previous research has demonstrated that the nonstationarity of the "simple" parity conditions was related to the nonstationarity of the real exchange rate, reflecting the very slow adjustment to fundamental real exchange rates. The need to finance the resulting trade deficits seemed to have caused similar nonstationary movements in the long-term bond differential. Support for this proposition is also given in this paper. Furthermore, our results point to a reversal of the linkages partly in the term structure from the long to the short end of the market, partly in the Fisher parities from the nominal interest rate to inflation rate. These results might be important for the conduct of monetary policy which works on the economy through short-term interest rates.

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