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Chapter 4

Q. 4.ST.1

Briefly describe how various economic factors can affect the equilibrium exchange rate of the Japanese yen’s value with respect to that of the dollar.

Step-by-Step

Verified Solution

Economic factors affect the yen’s value as follows:
a. If U.S. inflation is higher than Japanese inflation, the U.S. demand for Japanese goods may increase (to avoid the higher U.S. prices), and the Japanese demand for U.S. goods may decrease (to avoid the higher U.S. prices). Consequently, there is upward pressure on the value of the yen.
b. If U.S. interest rates increase and exceed Japanese interest rates, the U.S. demand for Japanese interest-bearing securities may decline (since U.S. interest-bearing securities are more attractive), while the Japanese demand for U.S. interest-bearing securities may rise. Both forces place downward pressure on the yen’s value.
c. If U.S. national income increases more than Japanese national income, the
U.S. demand for Japanese goods may increase more than the Japanese demand
for U.S. goods. Assuming that the change in national income levels does not
affect exchange rates indirectly through effects on relative interest rates, the
forces should place upward pressure on the yen’s value.
d. If government controls reduce the U.S. demand for Japanese goods, they place
downward pressure on the yen’s value. If the controls reduce the Japanese demand for U.S. goods, they place upward pressure on the yen’s value.
The opposite scenarios of those described here would cause the expected pressure to be in the opposite direction.