The exchange rate between the U.S. dollar and the Japanese yen is floating freely—both governments do not intervene in the market for each currency. Suppose a large trade deficit with Japan prompts the United States to impose quotas on certain Japanese products imported into the United States and, as a result, the quantity of these imports falls.
a. The decrease in spending on Japanese products increases spending on U.S.-made goods. Why? What effect will this have on U.S. output and employment and on Japanese output and employment?
b. What happens to U.S. imports from Japan when U.S. output (or income) rises? If the quotas initially reduce imports from Japan by $25 billion, why is the final reduction in imports likely to be less than $25 billion?
c. Suppose the quotas do succeed in reducing imports from Japan by $15 billion. What will happen to the demand for yen? Why?
d. Considering the macroeconomic effects of a quota on Japanese imports, could a quota reduce employment and output in the United States? have no effect at all? Explain.