Julien Pic, RachelChidraoui, Rawad Hijazi, Francisco Bulacia, Yifu Guo, Cristina Soliz

Problem #1
A. As the Indian authorities announced that they would allow foreign
investors to buy Indian government bonds the demand for Indian
government bonds increase since it is denominated in Rupees the
demand for Rupees in the foreign exchange market also increases thus
increases $/INR exchange rate, which means the Rupee appreciates.

The foreign sovereign wealth funds decided to invest in bonds thus the
supply for real loanable funds increases and decreases the real risk
free interest rate in India.

B. As the Reserve Bank of India will not intervene in the FOREX the
monetary base will stay the same but since there is an influx in

deposits the currency drain will decrease thus the money multiplier
increases creating an increase in money supply.
Problem #2
1. Deflation is the fall of the average price of all goods and services in a
country. Economic risks include a decline in consumption due to higher
savings because the purchasing power will be greater in the future.
Also, debt rises due to the fall of revenue since prices of goods and
services are lower and consumption has decreased.
2. The Japans Central Bank decided to break away from its previous
monetary policies and embark into a more aggressive type of policy.
They are as follows: double the monetary base, double the purchase of
Japanese bonds, and increase maturity of purchased bonds from 3 to 7
years on average. The objectives of these policies are to achieve 2%
inflation.
3. The Japanese aggregate demand (AD) is in the lower portion of the
intermediate range of the aggregate supply curve (AS) thus any shift in
AD will result in a change in real GDP and real price of goods. Since the
assumption is that Japan has a flexible exchange rate this means the
BOJ can change the exchange rate easily with policy. This flexible
monetary policy translates into the value of currency is free to shift
according to supply and demand. It can be a risk for the international
trade and investment decision but it also means the BOJ can control
monetary base and money supply. Since Japan has a high capital
mobility it is easy to attract foreign direct investment.

The BOJ is going to double the monetary base and purchase

government bonds which will increase the money supply, this will
increase the supply in the real loanable funds market which will
decrease real risk free interest rate.

The real risk free interest rate decreases so there will be an increase in
borrowing thus increase in consumption. This will lead to AD increasing
which means the real GDP will also increase and price level will
increase.

The growth of the real GDP increases the purchasing power of Japans
household sector, which means the imports of Japan will increase
because they will consume more. The supply for the Yen will increase
to FOREX thus the exchange rate will decrease and depreciate the Yen.

Japans
Microecono
mic
Variables

Change

Real GDP
Rise

Real Risk Free

Interest Rate
Fall

Explanation

The real risk free interest rate

decreases so there will be an
increase in borrowing thus
increase in consumption. This
will lead to AD increasing which
means the real GDP will also
increase and price level will
increase.
The BOJ is going to double the
monetary base and purchase
government bonds which will
increase the money supply, this
will increase the supply in the
real loanable funds market
which will decrease real risk

free interest rate.

Nominal
Interest Rate

Uncertain

Nominal Interest = Real Interest

rate + Inflation rate. We know
that the real interest rate will
fall but we dont know exactly
by how much the inflation rate
will rise. Therefore cannot be
sure if it is going to rise or fall.

Nominal
Exchange
Rate
($/Yen)

Fall

The imports of Japan will

increase because they will
consumer more. The supply for
the Yen will increase to FOREX
thus the exchange rate will
decrease and depreciate the
Yen.

Real
Exchange
Rate ($/Yen)

Fall

If Nominal Exchange Rate falls,

Domestic Price falls and Foreign
Price rises then Real Exchange
Rate will fall.

Current
Account
Balance

Rise

Due to the depreciation of the

Yen, Japan exports will become
more attractive for foreign
countries.
Therefore
Japan
exports will rise leading to an
increase in the Current Account
Balance.

Unemploymen Fall
t Rate

As the GDP increases, the

unemployment
should
decrease.

Financial/Capit Fall
al
Account
Balance

As there is a Current Account

surplus, it means Japan will
become a net International
Lender, increasing its Capital
Outflow
and
therefore
decreasing the Financial/Capital
Account Balance.

Reserves
Account
Balance

As we have a surplus in the

Balance of Payments, the
Reserve
Account
Balance
should rise.

Rise