In each case, assume the two countries under consideration are important trading

Question

In each case, assume the two countries under consideration are important trading partners. What happens to demand and/or supply of both currencies ($ and yen) and the value of the yen/$ exchange rate (appreciate or depreciate)?

a) there is an increase in the real interest rates in the US relative to Japan.

b) investment returns in the US descrease relative to expected returns in japan.

c) inflation in japan fell relative to the inflation rate in the US

d) the federal reserve raised interest rates fearing the inflationary pressures of a booming US economy.

Explanation / Answer

In this case, the demand of US$ will increase in comparison to Yen and thus the exchange value of US$ will be increased in comparison to Yen, while the demand for Yen will go down and the value of Yen/$ will depreciate as the people want to invest in US$ due to greater returns expectations.

As there is a decline in the investment return in the USA thus the investor will begin to invest in Japan due to higher returns and thus the demand for US$ will decline, the demand of Yen will increase and this increase in demand of Yen will appreciate Yen/Dollar value.

When the inflation in Japan decreases in comparison to the USA, the demand curve of Yen will shift towards right-hand side and thus the value of Yen/Dollar will appreciate and demand of Yen will increase resulting in a decline in demand for US$.

d) the federal reserve raised interest rates fearing the inflationary pressures of a booming US economy.

Higher interest rates will attract greater FDI and thus the demand of Dollar will increase in comparison to Yen and thus the Yen/Dollar will depreciate.

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