for each of the following six sentences, state whether the value of the dollar w
ID: 2681993 • Letter: F
Question
for each of the following six sentences, state whether the value of the dollar will appreciate, depreciate, or remain the same relative to the Japanese yen. Explain each answer. Assume that exchange rates are free to vary and that other factors are held constant.a. The growth rate of national income is higher in the United States than in Japan.
b. Inflation is higher in the United States than in Japan.
c. Prices in Japan and the United States are rising at the same rate.
d. Real interest rate in the United States rise relative to real rate in Japan
e. The United States imposes new restrictions on the ability of foreigners to buy American companies and real estate.
f. U.S. wages rise relative to Japanese wages, while American productivity falls behind Japanese productivity.
Explanation / Answer
a) The growth rate of national income is higher in the United States than in Japan. ANSWER. The value of the dollar should rise as more rapidly rising GNP in the United States leads to a relative increase in demand for dollars. b). Inflation is higher in the U.S. than in Japan. ANSWER. The value of the dollar should fall in line with purchasing power parity. c). Prices in Japan and the United States are rising at the same rate. ANSWER. According to PPP, the exchange rate should remain the same d). Real interest rates are higher in the United States than in Japan. ANSWER. The value of the dollar should rise as the higher real rates attract capital from Japan that must first be converted into dollars. e.) The United States imposes new restrictions on the ability of foreigners to buy American companies and real estate. ANSWER. The value of the dollar should fall as foreigners find it less attractive to own U.S. assets. f. U.S. wages rise relative to Japanese wages, and American productivity falls behind Japanese productivity. ANSWER. Higher U.S. wages and declining relative productivity weaken the American economy and make it less attractive for investment purposes. Assuming that a weak economy leads to a weak currency, the dollar will fall. From a somewhat different perspective, when a nation's productivity growth lags behind that of its major trading partners, the other countries will become more depreciating currency is the market's way of restoring balance. The lagging country regains its balance, but only by accepting a lower real price for its goods. In effect, the cheaper currency is the market's way of cutting wages in the lagging country
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