Question

multiple choice 2 points
we start with a 3 percent real interest rate in the united states and in japan. next, the real interest rate in japan falls to 2 percent, and the u.s. real interest remains constant. as a result,
the yen will appreciate and the dollar will depreciate.
the yen will depreciate and the dollar will appreciate.
both the yen and the dollar will appreciate.
both the yen and the dollar will depreciate.

Explanation:

Analyze the change in relative interest rates

The initial real interest rate is \(3\%\) in both the United States and Japan.
The real interest rate in Japan falls to \(2\%\), while the U.S. real interest rate remains constant at \(3\%\).
This creates a higher relative real return on financial assets in the United States compared to Japan.

Determine the direction of capital flows

Financial capital flows toward the country offering the higher real rate of return to maximize yield.
Investors will shift funds out of Japanese assets and into U.S. assets.
This capital outflow from Japan requires selling Japanese yen and buying U.S. dollars.

Evaluate exchange rate adjustments

The increased demand for U.S. dollars in the foreign exchange market causes the dollar to appreciate.
The increased supply of Japanese yen (as investors sell yen to acquire dollars) causes the yen to depreciate.
Therefore, the yen will depreciate and the dollar will appreciate.

Answer:

• the yen will appreciate and the dollar will depreciate.
• the yen will depreciate and the dollar will appreciate. (Correct answer)
• both the yen and the dollar will appreciate.
• both the yen and the dollar will depreciate.