50.1K

Verified Solution

Link Copied!

Consider two countries: Japan and South Korea. In 1996 Japan experienced relatively slow output growth of 1%, while Korea had relatively robust output growth of 6%. Suppose the Bank of Japan allowed the money supply to grow by 2% each year, while the Bank of Korea chose to maintain relatively high money growth of 15% per year. The bank deposits in Japan pay a 3% interest rate, iJPY=3%. The two financial markets in South Korea and Japan are well integrated; thus, the real interest parity holds. Assume prices are flexible in both countries. Use the general model in Chapter 3 to answer this question. You will find it easiest to treat South Korea as the home country and Japan as the foreign country. a. What are inflation rates in South Korea and in Japan? What are their expected inflation rates? What is the rate of depreciation of South Korean won relative to the Japanese yen, JPY, EJPYwon ? What is the expected real interest rate in Japan? What are the expected real interest rate and nominal interest rate in South Korea? ( 2 points) b. Suppose the Bank of Korea makes an unanticipated decrease in the money growth rate from 15% to 12% at time T. Assume Japan has nothing changes. Recalculate the inflation rate and nominal interest rate in South Korea. Recalculate the rate of depreciation of South Korean won relative to JPY. (1 point) Put your answers in the table below

Answer & Explanation Solved by verified expert

See Answer