1. In April 2020, the Canadian economy lost about 2 million jobs amid the Covid-19 crisis. According to Statistics Canada, the unemployment rate soared to 13%, up from the 7.8% recorded in March of 2020. Around the same period, inflation rate dropped from 2.2% in February to 0.9% in March and -0.2% in April. Use appropriate graph(s) to explain the following. (Total marks = 20)
a) Was there a trade-off between the unemployment rate and the inflation rate between the months of March and April 2020? How can the Phillips curve be used to answer this question? (5 marks)
b) If the unemployment rate and inflation are both rising, can this be explained by a movement along a given Phillips curve? What must be happening to aggregate demand and aggregate supply? What must be happening to the Phillips curve? (5 marks)
c) If the Bank of Canada continues to undertake expansionary monetary policy, how will the unemployment rate and inflation be affected? (Use both Phillips curve and aggregate supply – aggregate demand graphs in your explanation.) (5 marks)
d) Is there a trade-off between the unemployment rate and inflation in the long run? How is the long run aggregate supply curve related to the long run Phillips curve? (5 marks)
2. Suppose that there is a wave of pessimism in the economy due to Covid-19 and, as a result, the economy is operating below its natural level of output with high unemployment and low inflation. So, the central bank decides to stimulate the economy. Assume a small open economy with perfect capital mobility and a flexible exchange rate system. (Total marks = 20)
a) (i) Should the central bank increase or decrease the money supply if it wants to stimulate the economy? Explain. (1 mark)
(ii) List two monetary policy tools that the central bank uses to influence the money supply and explain how each tool should be applied to be consistent with your response in (i). (4 marks)
b) Which macroeconomic variables change immediately and in what direction? (5 marks)
c) Which macroeconomic variables change over the short run and in what direction? (5 marks)
d) What happens to employment and inflation? Does the rate of economic growth increase? (5 marks)
3. Consider a small open economy with perfect capital mobility and a flexible exchange rate. Suppose that net capital outflow (NCO) is negative at the world interest rate. Use a two-panel diagram to explain the following. (Total marks = 20)
a) What is the is the effect of an increase in world interest rate on (i) national saving, (ii) domestic investment, (iii) NCO, (iv) the real exchange rate, and (v) net exports? (5 marks)
b) What is the is the effect of an increase in the government budget surplus on (i) national saving, (ii) domestic investment, (iii) NCO, (iv) the real exchange rate, and (v) net exports? (5 marks)
c) What is the is the effect of an increase in the government budget deficit on (i) national saving, (ii) domestic investment, (iii) NCO, (iv) the real exchange rate, and (v) net exports? (5 marks)
d) What is the is the effect of imposing an import quota on (i) national saving, (ii) domestic investment, (iii) NCO, (iv) the real exchange rate, and (v) net exports? (5 marks)