It is often stated that the U.S. trade deficit with Japan results from Japanese trade barriers against U.S. exports to Japan.
a. Suppose that Japan and the United States trade goods but not assets. Show—with a diagram of the dollar–yen market—that a U.S. trade deficit is impossible as long as the exchange rate floats.
b. In the diagram, illustrate the impact of a reduction in Japanese trade barriers enabling an increase in U.S. exports to Japan. Would the dollar appreciate or depreciate against the yen? What would be the impact on U.S. net exports?
c. Now suppose that the United States and Japan also trade assets, but that the Japanese buy more U.S. assets than we buy of theirs. Could the elimination of Japanese trade barriers wipe out the U.S. trade deficit with Japan? Why, or why not?