Question

Use the AA-DD model to assess whether the following statement is true. Illustrate your answer using graphs.

"If the Bank of Japan responds to economic problems in Japan by expanding the Japanese money supply, then output in New Zealand will fall."

Suppose the nominal exchange rate, E¥/NZ$, was determined by the monetary model instead of the sticky price model. Would you be able to analyze this case using DD-AA? Why or why not?

Answer 1

The above statement is True. The reason is an expansionary monetary policy will lead to higher liquidity which raises firms ability to invest in production and hence production of Japan will increase. This will lead to higher exports to New Zealand, hence New Zealand production will decrease to offset imports.

If The nominal exchange rate if determined by expansionary monetary policy then it would cause the currency of Japan to depreciate as interest rate decrease and investors dont find it an attractive economy. The depreciation of Japanese yen will lead to higher exports and hence the New Zealand economy will import more and cause shortfall in their domestic production.