Question

Your firm exports goods to Japan, you need to forecast the value of JPY against the USD –i.e., you forecast St(USD/JPY). Clearly explain how each of the following will affect appreciation/depreciation of USD against JPY.

a. U.S. inflation has suddenly increased substantially, while Japan’s inflation remains low.

b. U.S. interest rates have increased substantially, while Japan’s interest rates remain low.

c. The U.S. income level increased substantially, while the Japan’s income level has remained unchanged.

d. The U.S. is expected to impose a small tariff on goods imported from Japan.

Answer 1

a) USD will start depreciating as inflation will reduce the real value of USD. This will help exports as USD becomes cheaper.

b) USD will start appreciating as investments flow to US increasing the value of USD. This will hurt exports as USD becomes dearer.

c) According to money market equilibrium, higher income level will lead to increase in money supply and higher interest rates to maintain the money supply. As interest rates increase, USD will start appreciating as investments flow to US increasing the value of USD. This will hurt exports as USD becomes dearer.

d) As tariff is imposed, the price will rise and demand of imports will reduce. However, the increase in USD price due to tariffs will go to the US Govt and Japan will receive fewer dollars. These dollars are then converted to Yen and as a result due to lower dollars, the demand for Yen will be lower. As a result, USD will appreciate. s investments flow to US increasing the value of USD.