Question

1. How does the Bank of Canada open market operation of purchasing bonds from chartered banks effect the components of the GDP = C+I+G+X-M? Be sure to mention exchange rates in your answer.

2. Draw the Canadian economy initially in long-run equilibrium at potential GDP of Yp and price level P1. Use that AD/AS model to illustrate the effect of each of the three following separate shocks to the model in the short run.

A) Explain what happens to aggregate output and the aggregate price level.

B) Determine whether the economy faces a short-run recessionary gap or an inflationary gap.

C) What type of monetary and fiscal policies will offset each particular shock to close the gap and return to potential GDP? Expansionary or contractionary? Explain.

1. Consumer confidence in the economy increases.
2. Housing prices fall and are not recovering.
3. Oil prices increase dramatically.

Answer 1

A)

The open market operation by the Central bank would increase the aggregate demand here. So here the Aggregate demand will shift to right thereby increasing the price level and output level in the short run.

Iver the short run, the AD shifts to right due to the expansionary monetary policy. Thus, the price level and output will rise in the short run only.

The over the long run, the economy comes to its original level as well.

B)

The economy is facing the short-run inflationary gap as the economy is operating above the full potential level here.

C)

The contractionary monetary and fiscal policies must be followed by the government and central bank of the country as the economy witnessing the inflationary pressure. The contractionary policies will shift the aggregate demand to left thereby leading to the fall in the price and the economy will operate at the full employment or potential level.

Rise in the inflation causes the decline in the exchange rate of the country. or currency depreciates.

Consumer confidence:

When consumer confidence is high, the contractionary fiscal and monetary policies must be followed by the government to reduce the aggregate demand in economy.

Falling house prices:

When the decline in the price of house occurs in the market, the economic slowdown occurs, thus recessionary pressure will build up in the market.

Thus expansionary policies must be followed by the government.

The oil price rise also introduce the recessionary pressure in the econony as the supply curve shifts to right thereby leading to rise in the price and fall in the output, here expansionary policies would increase the output and price will rise in permanently.