Question

1. Between 1982 and 2006, the S(¥/$) exchange rate moved from S(¥/$) 249.05 to S(¥/$) 116.34. During this same 25-year period, the consumer price index (CPI) in Japan rose from 80.75 to 97.72, and the CPI in the US rose from 56.06 to 117.07.

1. If PPP held over this 25-year period, what should the S(¥/$) exchange rate have been in 2006?

2. Was there a real appreciation or depreciation in the ¥ over this 25-year period (be sure to provide quantitative justification for your answer)?

3. Were there likely any associated positive or negative competitive pressures on Japanese exporters vs importers? If so, what likely happened to the competitive position of Japanese exporters? Japanese importers? Why (briefly)?

Answer 1

(a) If PPP held the same over this 25 year period then the exchange rates between the USA and Japan would be the same as 25 years ago that is in 1982. In 1982 1 USD = 249.05 Japanese Yen If PPP held 25 year period, it will be 249.05 in 2006.

(b) There was a real appreciation in the Yen over this 25 year period.

In 1982 1 USD = 249.05 yen and In 2006 1 USD = 116.34 Yen  

Japan was a country having less inflation than the USA. During 1982 to 2006 the consumer price index of Japan rose only from 80.75 to 97.72 whereas US CPI has risen from 56.06 to 117.09. The consumer price index is a broad measure of inflation within an economy in relation to the cost of goods and services. If inflation has risen the Purchasing Power Parity will be reduced.

The PPP is the exchange rate equal to the ratio of two countries price level for a fixed basket of goods and services. When the domestic price level is increasing, that countries exchange rate must be depreciated in order to return to the PPP.

Here inflation is higher in the USA than Japan so the USA had to depreciate its currency in order to return to the PPP that's why Japanese Yen has appreciated.

(c) Yes there will be positive and negative competitive pressures on Japanese exporter's vs importer's

The competitive position of Japanese exporter's

The countries which import Japanese products have become more expensive because of its strong appreciating currency but Japan exports have increased steadily from 1982 to 2006 because of its quality and low cost of production. Japanese exports are increasing at a high rate that is the reason why its currency is appreciating due to the huge demand for Japanese Yen by other countries. Currency Appreciation is generally considered negative for exporters due to the low affordability of its products by other countries

The competitive position of Japanese Importer's

The Japanese Yen have appreciated due to lower inflation the main advantage is that Imports will become cheaper. It will be a great advantage for Japanese importers.