(30 minutes to do this)
Suppose that the Prime Minister of Japan decides that he would like the Japanese currency to depreciate. Suppose also that prices are sticky in the short run but perfectly flexible in the long run. Suppose that he gets the Central Bank of Japan to increase the Japanese money supply. There is no expectation of long-run price stability.
a. What are the long and short-run effects of the value of the Yen? On Japanese interest Rates? On the Japanese price level.
b. Arising from your answer in a. what problem for the economy do you see with any policy that depreciates the Yen?
c. Suppose there is one other economy in the world, the US. Could the US authorities take action that would offset the effects of Japanese monetary policies? In your answer to c., you need only consider the long run.
Answer True, False or Uncertain questions and explain. Remember, all points are awarded for your explanation.
a. Interest rate parity means that real interest rates in all countries are the same.
b. Interest rate parity means nominal interest rates in all countries are the same.
c. Relative purchasing power parity means inflation rates are the same in all countries in the long run.