Suppose Japan and South Korea are on a floating exchange rate?
Suppose Japan and South Korea are on a floating exchange rate. Other things equal, if economic growth is more rapid in Japan than South Korea:
A) Gold Bullion will flow out of Japan
B) Japanese Yen will depreciate
C) South Korean Won will depreciate
D) Japanese Yen will appreciate
You can’t tell.
One major factor is the money supply. If the money supplies tracks the economic growth of both countries, then there should not be change in the relative value of their currencies. After all, what counts is what you can buy for your money. If the money supply increases faster than the supply of goods, you have inflation, and the money becomes worth less. If money supply grows more slowly than the supply of goods, you have deflation and money becomes worth more.
http://en.wikipedia.org/wiki/Quantity_theory_of_money
And you can’t assume the money supply stays constant. The money supply is never constant and faster growth almost always requires a more rapidly growing money supply. Otherwise you run into a credit crunch (in the form of a shortage of money) and can’t grow as fast. (Some have argued that growth in the economy generates growth in the money supply rather than vice versa, but either way, the two are connected.)
There is also the factor of the cause of the growth. If Japan’s growth is due to greater investment, then that greater investment itself will cause the Japanese Yen to appreciate. But if that growth is primarily due to a population which is growing faster, then there won’t be that impetus to increase value for the Yen.
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