Q. Consider two countries: Japan and Korea. In 1996 Japan experienced relatively slow output growth (1%), while Korea had relatively robust output growth (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 12% per year. For the following questions, use the simple monetary model (where L is constant). You will find it easiest to treat Korea as the home country and Japan as the foreign country.
a. What is the expected rate of depreciation in the Korean won relative to the Japanese yen (¥)?
b. Suppose the Bank of Korea increases the money growth rate from 12% to 15%. If nothing in Japan changes, what is the new inflation rate in Korea?
c. Using time series diagrams, illustrate how this increase in the money growth rate affects the supply of money MK, Korea's rate of interest, prices PK, real money supply, and Ewon/¥ over time. (Plot each variable on the vertical axis and time on the horizontal axis.)