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Exchange rate-trade balance and output

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Reference no: EM132415010

The yen floats against the dollar. The Fed funds rate is 2%, and the Bank of Japan rate is 0%. Japan is in recession, and the U.S. economy is at full employment. Assume the current exchange rate is 100 yen per 1 dollar.

a) Which is more likely to raise employment in Japan: an increase in fiscal deficits or an increase in the money supply? Use the IS-LM-FX model to illustrate how each affects the exchange rate, trade balance, and output.

b) Fiscal expansion is unlikely, and the Bank of Japan cannot reduce the interest rate further. Suppose it tries something inventive: it announces an exchange rate target. What should happen to the current exchange rate if the BoJ announces that it will pay 110 yen per dollar in one month, and the next month, and so on?

c) Following up on part b), how should this policy affect Japan's trade balance and output? Do you think it might work to raise output and employment in Japan?

Reference no: EM132415010

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