Japans Earthquake and Economic Impacts - Assignment Example

Topic: Japan’s Earthquake and Economic Impacts Name: XXXXXXXX Professor: XXXXXXXX Institution: XXXXXXXX Course: XXXXXXXX Date: XXXXXXXX 1.0 Describe how Japanese yen moves (depreciation or appreciation against Australian dollar) and why; The massive earthquake in Japan caused the yen to appreciate against the Australian dollar. The Australian dollar dropped by 0.8 percent to 82.32 yen on 11th March, 2011. There was also an earlier appreciation of the yen when the Australian dollar traded at 81.47 yen. This was the lowest exchange rate between the two currencies since 1st January, 2011 (Yui, & Swift, 2011 pg. 1). This is due to the rush by many investors and the Japanese government to try and contain loses caused by the earthquake. The high yielding assets in Australia are therefore being sold by those with investments in Japan since they are opting to divert their investment fund to help in reconstruction of the destroyed projects. Increase in demand of the Japanese yen leads to shifting to the foreign exchange demand curve to the right. This translates to increase in the exchange rate between the Australian dollar and Japanese yen. The expectations of speculators in the foreign exchange market exercise risk aversion in order to maximize their profit. They expect persons in Japan to liquidate investments in Australia for Japanese yen which is obviously highly demanded in Japan for both consumption and expenditures in form of reconstruction of damages that arose from the earthquake and the tsunami which followed immediately. The speculators hold their yen as they wait to sell it in a future date for higher prices than those in the current spot market. They may also sell it today but at a premium which will act as the opportunity cost of their expected future benefits in trading the yen (Yui, & Swift, 2011 pg. 1). After the 1995 Kobe earthquake, Japan increased its investment in insurance industry in a bid to mitigate such losses if they recurred. They increased purchase in foreign reinsurance since local insurance companies could not handle the increased demand in earthquake insurance covers. After these crises, it is expected that most foreign reinsurance will demand more yen to pay up the huge claims expected from Japan. This means that speculators have more reason to hold their Yen holding in expectations of much higher demands of the yen. Foreign reinsurance firms who expect claims from japan also may opt to buy the yen at current prices before increase in the price of yen to mitigate foreign exchange risks. This increases demand for yen hence pushing up its current price in the world market including the Australian foreign exchange market. Repatriated incomes flow from Australia to Japan will favor the yen as friends and relatives of victims of the Japanese earthquake will try to give financial support those who lost their property. They will need to convert their earnings from the Australian dollar to the yen since the yen is the dominant currency in Japan for local transaction. This increases demand for the yen in Australia pushing up the prices of the yen as seen in the foreign exchange market (Borwn, & Hogendorn, 2000, pg. 156-163). Appreciation in the yen will however be dampened by a move by the Bank of Japan to increase supply of money in the economy. This is by pumping funds to local banks which have been facing surge in demand for loans by residents in their effort to finance expenditures in reconstruction and consumables. What can Japanese central bank do to handle this crisis and how it will affect Japanese money market and foreign exchange market? The Japanese central bank can use similar tools as it used in the 1995 Kobe earthquake. This earthquake led to an estimated damage of about $100 billion, a figure much lower but close to estimated damage of the recent earthquake. The yen rose after the earthquake to a record high of 79.75 because investors repatriated funds to Japan from foreign countries. This also affected the stock exchange market in Japan. The Nikkei average fell by 0.5 percent on the day that the Kobe earthquake happened. It continued to fall by this magnitude in the following 4 days. When the quarter ended, the Nikkei had lost 16 percent. The reason for this fall was continued appreciation of the yen which would be expected to reduce exports. This would harm the economy tremendously since the Japan economy is highly dependent on exports (Nashikawa, 2011, Pg. 1). The Central bank of Japan responded by providing special loans of up to one trillion yen to the affected firms especially those with branches in the severely affected regions. These loans were offered for a period of one year. Japanese government also increased its public expenditure by 3.4 trillion yen. These sums were used in relief and reconstruction programs. After two years, the stock market had recovered all its losses indicating success in the government’s project (Nashikawa, 2011, Pg. 1). The government may increase expenditure to help in relief and reconstruction of shaken industries. This can be financed from internal or external debt like floating international bills and bond to be purchased by foreigners. The government can also get long-term loans from foreign governments, the International Monetary fund, the World Bank or grants and donations. When external debt is used, this will result to weakening of the yen. This is advantageous since it will boost exports which the country highly relies on. Exports will increase since they will be relatively cheaper. Increase in demand levels will result to increased production levels which means national income will increase. Higher production for export will result increase in demand for workers. This leads to higher employment levels and increase in wage rates. This will further increase national income through the multiplier process. Higher incomes will drive up demand for consumption hence need for more output to even serve the local commodity market. The multiplier process therefore continues and the national income increases bringing Japan closer to its initial economic condition before the catastrophic earthquake and tsunami (Carbaugh, 2008, pg. 215-222). Increase in production can only be finance by availability of investment funds. The government can lower interest rates in the economy by decreasing the commercial bank’s rate. This is the amount it leads the commercial banks. Commercial banks are therefore going to reduce their interest rates since the cost of advancing a loan will have reduced. This will increase the money available as credit to finance production and consumption. The government through the central bank of Japan can also purchase Treasury bill and bonds to increase money in circulation. This can be done by the government buying these bills and bonds at a premium meaning the interest rates of these bonds will be higher. This will increase money available for consumption which will stir economic growth. The central bank can also reduce the prevailing bank reserves ratio. This is the amount commercial bank are supposed to hold as deposits in cash ready to be with withdrawn by depositors. When this ratio is reduced, commercial bank can increase money supply in the economy through credit creation. This means more money will be available to finance reconstruction, production and relief. The central bank however should try however to maintain liquidity in the commercial bank sector to avoid further financial problems (Krugman, 2009, pg. 186-198). The government should try not to use internal debt since it would reduce money supply which will have a negative effect to the economy. Printing of notes and coins is also not advised since it is inflationary. It would also lead to loss of confidence by investors hence foreign direct investments would reduce. The stock market would be affected adversely since stocks prices will be on a downwards trend. However, the yen would depreciate with this kind of intervention. International debt is advisable and reduction of interest rates in the money market could be advantageous to make available loans for investment (Borwn, & Hogendorn, 2000, pg. 167-176). How would Japan’s policy affect the Australian economy? Japans policy is aimed at reducing the price of the yen against world currencies. This means it would end up making imports from Japan cheaper. Australia will therefore increase its imports from Japan since they will have become relatively cheaper. The dependency of Australia’s economy to imports will increase making it susceptible to international price fluctuations (Carbaugh, 2008, pg. 201-209). In the short-run, Japan may opt to set import subsidies through increased government expenditure. This is because of increased demand in the country as a result of non-operational producers who used to supply the domestic market. Australia’s exports to Japan will increase; raw materials like coal. Through the multiplier process, income will even increase by a larger magnitude because of increase in employment levels and investment as inputs for production meant for export. Income levels will also rise in Australia. As the government attracts foreign direct investment in Japan by offering tax cuts and attractive international bills and bond, fund will move from Australia to Japan. This may lead to deficit Balance of Payment in Australia’s budget. If the government opts to print money, it might increase the damage on BOP since more funds will divert to Japan where the investors have more confidence in the economy. In general, Australia’s economy is expected to grow if it makes non-inflationary policies as it takes advantage of increased demand in Japan’s economy (Krugman, 2009, pg. 156-167) References Borwn, B. & Hogendorn, S, 2000, International Economics: in the age of Globalization, New York: Broadview Press Ltd. Carbaugh, R, 2008, International Economics, 13th ed. Ohio: Cengage Learning. Krugman, P, 2009, International Economics: Theory and Policy, London: Pearson Addison-Wesley. Nashikawa, Y, 2011, Factbox: Japan markets and economy after Kobe earthquake, Retrieved on 29th April, 2011, http://www.bloomberg.com/news/2011-03-13/aussie-drops-to-six-week-low-versus-yen-as-japan-quake-saps-risk-appetite.html Yui, M. & Swift, R, 2011, Australian, New Zealand Dollars Fall on Japan Earthquake, Reactor Concern, Retrieved on 29th April, 2011, http://www.bloomberg.com/news/2011-03-13/aussie-drops-to-six-week-low-versus-yen-as-japan-quake-saps-risk-appetite.html Read More