Question

Use the money market and foreign exchange models to describe how the expansionary monetary policy in Japan and the restrictive monetary policy in the U.S. affect the interest rates of these two countries i Japan and ius) and the nominal exchange rate between the Japanese Yen and the dollar (Eye). Assume that Japan is the domestic economy and the U.S. is the foreign economy and that these policies are temporary. Do not forget to use the U.I.P. equation and graphs of the Money and Foreign exchange markets to support your answer.

Answer 1

The national and foreign exchange markets are interrelated.

Whenever there is an increase in the money supply in the economy, interest rates will fall. As a result, the rate of return of domestic currency deposits decreases and leads to a decline in the local currency.

With the decline in money supply in the economy, interest rates are rising. As a result, the rate of return of local currency deposits increases, leading to a rise in the rise of the local currency.

For example, the US dollar and US dollar markets in the foreign exchange market with respect to foreign currency.

Dollar/euro exchange rate. Es Return on dollar deposits Foreign exchange market E - - - Expected return on euro deposits Rates of return in dollar terms) LIRY Money market U.S. real money supply increasing) U.S. real money holdings