Question

1. The coronavirus is currently wreaking havoc on the world economy. There are many reasons for this, so let’s simplify by focusing on just one. Suppose the primary effect of the coronavirus is to create “uncertainty”, which leads investors to increase their demand for “liquidity” (i.e., it increases the demand for money relative to other assets). Use the DD-AA model to show how this would affect the US economy. What happens to US output and the value of the dollar? US policymakers are currently debating whether to respond by cutting interest rate or increasing government spend- ing. Which of these policy responses would Canada favor? Which would China favor? (Hint: The Canadian dollar floats against the US dollar, whereas the RMB is pegged to the US dollar).

Answer 1

COVID-19 OR Corona virus is disrupting the economy. It reduces labour supply, prevents the globaly suppy of goods,reduces demaqnd for US goods and services. It increases volatility in the financial markets.

to its credit the Federal Reservevhas desperately cut its interest rates. A 30% crash in oil prices on recent days sent shockwaves through global financial markets already reeling from corona virus woes. The US dollar dropped half a percent against its international pees.A major corona virus epidemic in the US might be like a big sound that shuts down most economic activity and social interactions. The stock market volatility is driven by uncertainty.

DD-AA MODEL

IT CONSISTS OF THREE MARKET MODELS

1) FOREX market

2)Goods and Service market

3)Money market

AA curve represents asset market equilibrium derived from the money market and foreign exchange markets and DD curve representing goods market equilibrium.

It shows us to learn how changes in macroeconomic policy.

the AD function with exchange rate E$/1 INTERSECTS THE 450 line at point G which determines the equilibrium level of GNP given by Y$1. E$/  rises from E$/2 . A depreciation of the US dollar with respect to British pound. Dollar depreciation foreign goods and service relatively more expensive and domestic goods relatively cheaper. AD shifts up to the point H. If the economy were at apont above the DD curve, I. where AD is greater than aggregate supply(Y) and GNP ncreases. it continue until economy reaches AD=Y AT POINT H. Now consider point J right of the demand cuve.where Y less than AD. gnp falls it continue until AD=Y. DD curve depicts the relationship between changes in one EXOGENOUS VARIABLE like CORONA VIRUS abd one ENDOGENOUS VARIABLE interset rate which is cut by the US GOVT. The Exogenous variable assume to change is the EXCHANGE RATE. The ENDOGENOUS variable affected is the GNP. FOR EXOGENOUS VARIABLE dd curve shifts , INVESMENT DEMAND falls, shifts from I1 to I2.

DD curve effects from an decrease in investment demand. change in any exogenous variable that reduces aggregate demand. decreases govt demand , increases tax, decreases tranfer payments.