The question is asking me to forecast the spot exchange rate 1 year into the future if Japan is running a current account surplus and the US is running a current account deficit. So I would say that the Yen should appreciate in value based on this, but I don't really understand why that would happen.|||if a country, exports more than it imports..the balance of trade is a surplus. lets say japan has this situation, it is exporting more means japan is selling goods abroad, if people from outside japan want them, they have to pay Japan in Yen..this will increase demand for Yen...whenever demand increases, what happens to price (simple economics demand and supply curve)...the price increases. thus, Yen will increase in price, in other words, it will become more expensive in terms of other currencies.
Similarly, USA has a deficit, means that the country is importing more than it is exporting. importing means u purchase goods from another country, for that u have to pay them. Lets say USA imports products from Japan, can USA pay the money in Dollars in Japan?? no, it has to first purchase Yen. how will USA do that? they will give dollars to Japan govt, thereby increasing the supply of dollars in other countries...so USA supplies more Dollars, the supply of dollar rises, thereby decreasing its price (same demand supply rule of economics)....
we see therefore, that when a deficit is there in the economy, value of the currency will fall. whereas, when a surplus is there, value of the currency rises.
hope it helps
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