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Q. Use the monetary approach in the long run to answer this question. Suppose the Bank...

Q. Use the monetary approach in the long run to answer this question. Suppose the Bank of Japan decides to increase its money supply in order to fight continued deflation in the economy. If we assume that no other policy response takes place in the US, what would happen to the US dollar-Japanese yen exchange rate E$/¥? Will the dollar appreciate or depreciate against the Japanese yen? Explain. (10 pts)

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Answer #1

If money supply increases in Japan, then interest rates go down considerably and therefore investors pullout money and invest in US if interest rates are comparatively higher which causes appreciation of US dollar and thus exchange rate appreciation takes place against Japanses yen as investors seek better return on investment and hence invest in countries with higher interest rates regime.

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