Question

5) Suppose you learn that the current exchange rate for the Japanese Yen is $1 = 120 yen.

a. If you expect Japanese monetary growth to be a total of 25% larger over the next ten years than US monetary growth, what is your best guess as to the exchange rate ten years from now? What theory underlies your prediction? Explain why we apply this theory here over a long run period, like 10 years, rather than over a short period, say less than a year?


b. If you expect that in addition to the higher money growth rate in Japan above, you also expect the output growth rate to be higher in Japan by 30%. Would you predict that the value of the Japanese yen will appreciate or depreciate relative the dollar (more or fewer dollars per yen).

Answer 1

a. Monetary growth would be higher in Japan and hence As per quantity theory of money, more Yuans will circulate and in short term Yen will depreciate as more supply would be there and also more demand will lead to more imports. For a longer period of time if exports are elastic then Yen will appreciate as more exports can be made from Japan. Over a longer time goods and services for export-import adjust as per changed demand-supply which is not possible in short term.

b. Average annual growth rate will then be 2.5%. This would be a good growth rate. It will mean that all components of GDP would grow.

GDP is gross domestic product. It is sum total of values of all final goods and services produced in a country in a year.

It can be calculated expenditure method by using by a formula: C+I+G+(X-M)

where C= Consumption expenditure

I= Investment expenditure

G= Government expenditure

Net exports = exports -imports.

This would mean that demand for Yen grows and hence Yuan will appreciate in terms of dollars. As per the monetarist theory, long run aggregate supply curve (LRAS) would shift right and hence Yen will appreciate. Every economy takes time to show structural change and all factors of production can be changed over time.