Homework #3: Solutions
Ryoichi Imai
2005/01/12
The purpose of this homework is to provide an opportunity to have your own understandings of the reading materials in ahead of the class discussion. Type your answers on A4 papers. At the top of your homework, type your name and e-mail address.
If you fail in submitting your work in the class hour, you can leave it in my mailbox, located at the ground level of the International Student Center.
The numbers in ( ) represent the corresponding pages. Write your answers in your own words. Never copy a large part of the paragraph, even if you do not know the answer.
A. Answer to the following questions, based on Chapter 3, "Exchange Rates" of Japan's Lost Decade by Hiroshi Yoshikawa.
What is the Bretton Woods System? How were the values of currencies linked to the US dollar and gold? (84)
The Bretton Woods system was the international monetary system, which was signed in 1944 and maintained until 1971. Under the system, the US government was responsible to keep the dollar price of gold, which was $35 per ounce, and the other countries were responsible to maintain the exchange rates of their currencies with the US dollar.
What does the "buyer/seller of last resort" mean under the fixed exchange rate system? (85)
If there are too many buyers for the domestic currency, the government has to release unlimited amount of the domestic currency. On the contrary, if there are too many buyers for a foreign currency, the government is required to supply enough amount of it. In either case, the government must stand outside the market, and stockpile enormous quantities of the domestic or foreign currencies to fulfill this market adjustment function.
Why do governments maintain some foreign currency reserves even under the floating exchange rate system? (86)
They want to influence foreign exchange rates by intervening the market as massive sellers or buyers.
Why do market players behave as if they were participating a "beauty contest"? (88)
Whenever a convincing story emerges about the fundamentals of the economy, the market players tend to move in a single direction. Keynes called this tendency a "beauty contest", in which the players can win if they vote for the woman who attracts the largest number of votes, no matter if she is really beautiful or not.
What is the "Purchasing Power Parity"? (89)
The prices of tradable goods will inevitably become identical across countries.
There is no physical productivity difference of taxies in Japan and Australia. Why is the taxi service in Tokyo as six times expensive as in Sydney? (92)
The taxi service is a typical non-tradable good, which is not traded across nations. The faster the productivity of tradable goods grows, the faster the domestic currency appreciates against foreign currencies, which results in the higher prices of the non-tradable services and commodities.
State the two reasons to explain the price difference of nontradables across countries? (93)
First, the productivity grows slower in the domestic non-tradables sectors than in the foreign equivalents. Second, the productivity grows faster in the domestic tradables sectors than in the foreign equivalents.
There is still a large gap in living standards between Tokyo and New York.. What does this mean? Is this a bad thing or good thing? (94)
It is meaningless to compare the living standards between Tokyo and New York, using actual exchange rates, which are determined by PPP of tradable goods, because we do not live on cars and PCs alone. The high prices of nontradables in Tokyo are the reflection of the fast growth of the productivity of Japan's tradables.
Is there a theory that predicts that the PPP based on living standards converge with the actual exchange rates? (94)
There is none.
What is the difference between the PPP based on tradables and the PPP based on living standards? (95)
The PPP based on living standards include both tradables and nontradables, while the PPP based on tradables include the former only.
Why did Japan experience a "lost decade" in 1920? Explain it using the words "exchange rate misalignments"? (96)
During the World War I, most countries, including Japan, abandoned the gold standard in order to prevent gold from flowing out. After the war, the government of Japan insisted to restore the gold standard at the prevailing exchange rate prior to the war, while the actual rate was 20% less than its pre-war level. In order to raise the value of yen, the government took a deflationary policy, which inevitably damaged Japan's development throughout the 1920s.
How did Takahashi succeed in stimulating the Japanese economy, which were suffering from the overvalued fixed exchange rate? (97)
Takahashi abandoned the the gold standard and expanded money supply and fiscal expenditures, to recover the economy from depression associated with the overvalued yen.
What are the two possible explanations for the long-term appreciation of the yen? (98)
First, there is a considerable gap in inflation rates between Japan and US. Second, there is a considerable gap in the productivity growth rates in the nontradables sector between Japan and US.
Why did the yen appreciation over the past 25 years occur? (99)
The most important factor of the yen's everlasting appreciation is the growth in labor productivity in the Japanese export goods industries.
Pick up two examples of occasional misalignments in the actual exchange rates? (100)
First, the US government adopted the "strong dollar" policy under the "Reaganomics" in the early 1980s, which undervalued the yen too much. Second, the ultra-high yen era of 1994-1995 seriously obstructed the economic recovery, and accelerated the "hallowing-out" of the Japanese industry.
B. Answer to the following questions, based on Chapter 4, "Japan's Manufacturing and Nonmanufacturing Industries" of Japan's Lost Decade by Hiroshi Yoshikawa.
What is the "value-added" productivity, which is different from the physical productivity? Explain it by an example of the restaurant industry? (108)
Even in an industry where physical productivity growth is low, a firm can increase its value-added by increasing the price if there is sufficient demand for that product or service. There are limitations on physical productivity growth of the restaurant industry. But some (luxurious) restaurants successfully generate sufficient value-added to overcome these limitations.
Along the growth path, what can we say about the GDP share of the primary, secondary, and tertiary sectors? (110)
The GDP share of the tertiary sector has been increasing over the past 30 years, while those of the primary and secondary sectors have been declining. This change reflects consumers' demand shift from goods to services.
Why has the GDP share of the tertiary sector been increasing, although the productivity growth of the service industry is much slower than that of the manufacturing industry? (111)
The low growth era since 1970 has been witnessing a demand shift from manufacturing to nonmanufacturing industries, because the higher productivity growth in the manufacturing industries has made it possible for consumers to save their expenses in goods and allocate more money in purchasing services.
What is the big problem of the Japanese economy that we can learn from Fig.4-1? (113)
In the nonmanufacturing sector, the labor productivity has been growing at a much slower speed than the capital-labor ratio since 1970. This means that the capital has been used inefficiently in the nonmanufacturing sector.
What can we learn from Table 4-4? (a) What is the long-run trend in the employment categories? (b) What is the distinctive feature of the employment categories in comparison with other advanced countries? (117)
(a) The share of employees has been rising from 50% in 1960 to 80% in 1997, accompanied with declining numbers of workers in self-employment and family businesses. (b) The share of salaried employees is much lower in Japan than in Western nations.
Why did the SMEs survive while the Japan's economy had moved into an entirely new phase around 1970? (119)
The government has been taking some protectionist policies to help sustain SMEs, such as the Large Retail Store Law, which restricted the growth of large retail outlets.
What is the source of inefficiency of Japan's construction industry? And how is it inefficient? (120)
Over half of construction firms receive orders and consigned them to subcontractors, but don't actually build anything. This weird state has been supported by the policy to oblige local governments to target certain percentage of orders given to SMEs, even if they have no construction capabilities. These orders are simply passed up to the leading general contractors, and the local firms pocket the profits.
State the two different issues which are currently confused in Japan's agriculture controversy. Explain the situation using an extreme case. (124)
Protecting Japanese agriculture and protecting farming households are different issues. However, the government has been protecting farming households in the name of preserving domestic agriculture. This is absurd if we think about an extreme case. The government has supported agriculture households as if it supported doctors' families by paying them a substantial sum of money to guarantee doctors' children to become doctors.
Why do agriculture households hold financial assets that are more than 50% higher than the average for all households? (125)
The farming households can realize the capital gains of holding lands by selling a portion of them whenever they want.
Why are farmers so unwilling to sell their lands? (126)
The tax burden (property and inheritance taxes) on agricultural land is extremely low, so the farmers can wait for the ideal timing to convert their excess land.
Why did the crash of the bubble economy bring the harsh condition on the nonmanufacturing industries? (130)
The pricing of nonmanufacturing sector goods has been heavily influenced by the sales management expenses of manufacturing companies. Since the bubble crashed, the manufacturing firms have been making every effort to save their sales expenses. For example, corporate entertainment expenses have continuously declined since the bubble economy collapsed.
Why did the deregulation and the IT revolution deteriorate the profitability of local electric shops and small town booksellers? (131)
The advancement of high-volume retailers has made it hard for local electric shops to generate enough value-added to remain afloat. The IT revolution has induced book lovers to place their orders through the Internet.
What is wrong in Fig. 4-2? (132)
The thick line must be marked with "Overseas Travelers" and the thin line with "Domestic Travelers".
What can we learn from Table 4-6? (133)
Both the net profit and the self-capitalization rates have been deteriorated since the crash of the bubble economy, which means that the business environment for the SME has become more harsh for them.
How did the poor performances of SMEs affect the recession of the 1990s? (133)
Capital investment by SMEs has remained stagnant, which has made the economic recovery even weaker.