Question

1.

Use the following information to answer the next two questions.

Investors expect inflation rates over the next twelve months in the US and Japan to be 8% and3%, respectively.  The current exchange rates for the two currencies are as follows:

C$.007/¥,   C$1.02/$

Suppose that twelve months from now, the exchange rate between US dollars and yen is $.0071/¥.  According to relative PPP, what be the impact of this new exchange rate on the USbalance of trade?  (Assume the US is the home country and ignore any possible feedback loop.) Round intermediate steps to four decimals.

		The US BOT will increase.
		The US BOT will decrease.
		The US BOT will not be affected.
		Cannot be determined.

2. Use the information from #1

What should have been the percentage change in the value of yen in terms of US dollars be according to relative PPP?

Answer 1

1. US inflation= 8%, japan inflation= 3%

Spot exchange rate= C$0.007/YEN and C$ 1.02/ $

i.e. 1/0.007= yen 142.8571/ C$ and 1/1.02= 0.9803$/c$

After inflation, 142.8571/1.03= 138.6962 yen/ C$ and 0.9803/1.08= 0.9077$/ C$

Therefore from 0.9803 to 0.9077, US $ has appreciated against C$ So, Imports will increase and exports will decrease.

As BOT= Exports-Imports= negative as per our question. So, BOT will decrease.

2. Yen/$= 142.8571/0.9803 = 145.72794 (before inflation)

Yen/$= 138.6962/0.9077 = 152.7996 (after inflation)

therefore, % increase= (152.7996-145.72794)/ 145.72794= 4.8526%