Dollar movements and inflation: a cointegration analysis

Many studies have concluded that changes in US dollar values affect US prices. However, since exchange rates may reflect underlying economic conditions, this result may be spurious if those conditions are ignored. Recent advances in time series analysis permitted investigation of both the short and long term interactions between the US price level and the yen/dollar exchange rate, taking into account the effects of changes in domestic economic activity, such as income, interest rates and monetary policy. Examination of these interactions helps to determine to what extent the yen/dollar exchange rate impacts the domestic price level. The finding is that there is no long term relation between the two variables. In addition, the results suggest that in the short run, monetary authorities respond to changes in the consumer price index and Japanese exchange rates; however, the price level does not respond to change in the exchange rate.