Question

1/ An article in the Economist notes that gasoline prices in Japan were increasing “because of the government’s efforts to drive down the yen.”

a.   Why was the Japanese government trying to drive down the yen?

b.   Why would driving down the yen have increased gasoline prices in Japan?

Source: “Man with Plan,” Economist, July 20, 2013.

2/ What's the difference between the nominal exchange rate and the real exchange rate?

3/ Discuss what factors could cause a real depreciation.

4/ Assume that the United States, an open economy, has slipped into a recession. Policymakers consider two different strategies for increasing aggregate demand. First, the Federal Reserve can use open market operations to lower the federal funds rate by 0.5 percent (50 basis points). Second, Congress and the president can pass legislation to cut income taxes.

a.      In an open economy, as national income or GDP increases, so will spending on imports. Define the marginal propensity to import (MPI) as the increase in imports divided by the increase in GDP. Assume two different values for the MPI for the United States: MPI = 0.10 and MPI = 0.20. For which value of the MPI would an income tax cut have a greater effect on aggregate demand? Explain your answer.

Answer 1

1.

a. Driving down the yen would help Japanese exporters as export become more profitable when the domestic currency depreciates. When domestic currency depreciates, an exporter receives more domestic currency for a given amount of goods. Therefore, the Japanese government drove down the value of yen to promote exports and export-driven economic growth.

b. Japan is an importer of gasoline. Depreciation of domestic currency makes imports costlier. This is because importers need to spend more domestic currencies for a given amount of import. This is why depreciation of yen resulted in higher gasoline price.