Since the early 1980s, the real exchange rate between U.S. goods and Japanese goods has climbed, relative to the nominal exchange rate (yen/U.S. dollar). What does this imply about economic conditions in the two countries?
What will be an ideal response?
Any change in the real exchange rate relative to the nominal exchange rate reflects a change in the relative price levels. The real exchange rate trends higher when domestic (U.S.) inflation is higher than foreign inflation. Lower inflation in Japan suggests that its economy has been generally weaker and growing more slowly than the U.S. economy.
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