Suppose there are two countries, the US and Japan operating under a flexible exchange rate regime. Japan elects a new prime minister who convinces the Bank of Japan (BOJ) to pursue an expansionary monetary policy. Assuming the standard Keynesian assumptions show what happens to interest rates, output and the exchange rate in the US. To do so, use the following diagrams all pertaining to the US: Keynesian cross on the top left, the IS - LM diagram on the bottom left and the FX market on the bottom right. Label the initial point as point A and point B as the new equilibrium after the monetary expansion in Japan. As is customary, label the initial output (Y), interest rate (i), and nominal exchange rate (E) with a subscript 1, and the corresponding values after the monetary expansion in Japan with a subscript 2. Note again that we are modeling US economic variables, not those for 2 Japan.

Discuss the factors influencing the trade balance for the US. There are three to discuss (ignore any J curve effects).

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Use the identical diagrams as you did for part a) but this time, instead of Japan increasing output via expansionary monetary policy, they increase output via expansionary fiscal policy (an increase in G). Using the customary labeling as above, locate points A and B.

Discuss the factors influencing the trade balance for the US. There are three to discuss (ignore any J curve effects).

How would your answers change to parts b) and d) above if we assume J curve effects?