Consider the case of Japan and Singapore. Japan has been struggling to post positive growth for decades, while Singapore’s economy continues year after year to rise among the ranks of Asian nations. Let us suppose that Japan manages 1% growth while Singapore averages 5%. To reverse the nation’s problem of falling prices and stimulate growth, the Bank of Japan has allowed money growth of 2.5% since the Great Recession. Singapore’s central bank, the Monetary Authority of Singapore, had not been stingy with money growth (broad money growth rose by double digits earlier in the decade), but now money growth is flat (zero). Based on these facts, answer the following questions:
What does economic theory say will be the inflation rate in Singapore? In Japan? What does theory predict about the Singapore Dollar/Japanese yen exchange rate?
Suppose the MAS decides to up its rate of money growth to 2%. What will be the effect on the Singapore Dollar/Japanese yen exchange rate?
In this case, the country’s export will become relatively cheaper. On the other side, import will be relatively more expensive. MAS or any country’s policy does this to lower the exchange rate, weaken the financial account and strengthen the current account. The rise of Singapore’s GDP will tend to increase the demand for imports. The increase in demand imports will also impact the exchange rate directly. The rate of money growth to 2% will probably tend to devalue the currency in respect to the international currency and hence domestic costs will increase. The Japanese exchange rate is not related to the Singapore’s policy change directly. Hence, Japanese exchange rate will improve against Singaporean currency.
In fact, the current inflation rate in Japan is the same as in Singapore, 0.5%. Should the exchange rate be stable?
The inflation rate directly affects the exchange rate. Keeping the inflation rate of 0.5% which seems to be quite lower would not have an effect on the costs/prices significantly. Similarly, Singapore with current inflation rate which is 0.5% will not entirely stabilize the exchange rate. Lower the inflation rate is, higher the currency exchange rate is.
After Trump’s win this past November, the stock market rallied. The 14% run-up in stock prices after the election caused household wealth in the U.S. to increase considerably. Stock prices have since come back down some. But what’s next? Your job is not to predict the direction of stock prices, but to explain what would be the foreign exchange influence of various scenarios. MAKE SURE YOU USE EQUATIONS.
Suppose stock prices start to rise again, as does wealth. This leads to lower domestic savings as consumers are happy to have the market “do their saving for them.” US interest rates thus rise. What is the effect on E$/€? (FYI: feel free to use any bilateral exchange rate (not necessarily the euro) or even the trade weighted value of the dollar.)
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