Do Oil Price Fluctuations Alter the Exchange Rate in Japan?

Determinants of exchange rate fluctuations have long been a topic of interest for the economists. Although there exists a large number of studies that attempt to decipher the exact relationship between the price of oil and exchange rate, a clear answer still remains absent. Most studies suffer either from ambiguous findings or from the severe limitations stemming from the assumption of non-stationarity. In this chapter, the relationship between oil price differentials and real effective exchange rate of Japan is thoroughly investigated by utilizing sophisticated research tools that provide additional degree of rigor to the results. Maximal Overlap Discrete Wavelet Transform (MODWT) is used to decompose the time series into different frequencies and then the relationship between the two series at different time frequencies are examined with the use of standard econometric techniques. This chapter finds that international oil prices vibrate the exchange rate at the short term frequency bands. However, no evidence of causal relationship is found at the lower time scales, although such evidence is found at higher time scales.