Question

PART B

Suppose the Australian dollar and Japanese yen are initially in equilibrium at ¥100 = $1.

The Japanese economy experiences a recession with decreasing real GDP growth.

At the same time, the Reserve Bank of Australia lowers the cash rate. Interest rates in Japan are unchanged.

Additionally, there is increased trading in the AUD by speculators.

REQUIRED:

1. How will these economic conditions in Japan change the exchange rate between the dollar and the yen?Explain your answer with reference to the change in the demand for and or supply of Australian dollars (Note: a diagram is not required for this question).

2. Explain the impact that the change in the exchange rate in (i) above will have on:

- the price of Australian exports to Japan;

- the price of Japanese exports to Australia;

- Australia’s net exports and

- Australia’s real GDP.

Answer 1

i)

We are given that the AUD currency has a pretty good demand, thanks to the increased trading claimed by the speculators. This means that the value of AUD increases due to the surge in demand. Along with that, Japan is in recession, meaning that demand for Yen decreases substantially due to the slump in GDP growth which doesn't attract foreign investors. So, exchange rate between dollar and yen increases, that is 1$ >¥100

Say ¥120= $1. This value shall depend on the magnitude of the effects mentioned above.  

ii)

Because of this turnaround in the exchange rates

• The price of Australian exports to japan increases. This is caused due to the excess valuation of AUD in comparison to Yen, and the japanese thus feel the burden in purchasing power in the form of increased prices.
• The prices of japanese exports to Australia decreases. This is primarily due to 2 reasons: GDP slump and the weak exchange rate of yen. A growth slump in GDP has already reduced the real prices, and on top of that a weaker currency demand for Yen when compared to the AUD concedes with the fact that the prices of Japanese exports has decreased in Australia.
• Australia's net exports increases because the valuation of exports is far more when conpared to the valuation of imports in this case.
• Australia's real GDP increases as a result of the above observation. The demand for AUD is also higher, thereby increasing private investment too.

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