Question

After global financial crises, US dollar deprecated against the Japanese Yen significantly, from 1 $ = 110 Yen to 1 $ = 75 Yen. It is argued that different monetary policies between US Fed and Bank of Japan triggered the depreciation of dollar. Specifically, the Fed adopted quantitative easing while Bank of Japan maintained a relatively stable money supply. Please use asset approach to explain the depreciation of dollar. Draw two figures – equilibrium of money market and that of foreign exchange market.

Answer 1

here we can clearly know that the dollar getting weaker against the yen following the increase in reserve balances in the United States, until the BOJ increased its own reserve balances and the dollar then strengthened against the yen. The yen is getting weaker against the euro as reserve balances are increased in Japan and there a reversal is seen when reserve balances are increased by the ECB.

Exchange rate effects of reserve balance changes can also occur for small open economies, but they are very normally due to direct intervention on the currency markets. In the case of Switzerland, for example, reserve balances are used to finance direct interventions in foreign exchange markets. Vector autoregressions can then be used to examine the impacts. In fact, according to empirical results reported in Taylor (2017), there is significant two-way causality between the Swiss exchange rate and reserve balances.

There is other evidence which shows us very clearly that exchange rate volatility and capital flow volatility have increased in recent years. this rastic change has led the dollar rate to be depreciated. When a currency war is prosecuted, exporters in other countries may complain that they are being undercut, and foreign policymakers may object to what looks like a diversion of demand away from their own economies, possibly leading to increased unemployment.