Question

It is estimated that the recent global outbreak of Covid-19 has caused a downturn in global GDP by 2-3%.

1. Explain the reasons of the recession using the GDP equation (Y=C+I+G+X-M)

2.Suppose the Canadian government wants to use Fiscal policy to stabilize the economy during the time of this outbreak.

3. What actions should it take in terms of In terms of Monetary Policy? Discuss how this policy work.

4. Include graphs of the Monetary policy

Answer 1

1. The given equation is

Y=C+I+G+X-M

where C=consumption, I=investment, G=government spending, X=exports, M=imports.

Now that we have described the variables, its pretty easy why the global downturn if happening. Due to the lockdowns, many outlets are closed. This includes restaurants, malls, cinema halls, most regular shops, e-commerce and more. This massively affects consumption. Consumption, C, has decreased by massive amounts.
Then there is investment. As consumption goes down and returns become lower or negative, there is no sense in investing. As people and corporations become pessimistic, they invest lower too.
Government spending is actually higher, as governments world over combat the virus and invest in medical facilities, emergency services, medicines, basic necessity services etc.
X-M is irrelevant in the world perspective as its net zero. When a country is importing, another is exporting the exact amount and hence X-M is zero for the world.

2. While question 2 isnt really asking anything, i assume its saying how government can expansionary fiscal policy to fight the downturn. Government can use fiscal policy in two ways- it can increase its own spending, G, and/or lower taxes to increase consumption. Increase in both will increase GDP, as can be seen from the equation.

3. An expansionary policy also increases GDP, but in slightly different way.

Expansionary monetary policy works by expanding the money supply faster than usual or lowering short-term interest rates. It is enacted by central banks and comes about through open market operations, reserve requirements, and setting interest rates. The central bank can reduce the required reserve ratio (thus increasing available funds for lending), by lowering the benchmark discount rate or by open market operations (buying treasury bonds in the open market).

This is shown in the graph below

As money supply increases, the interest rate goes down. Lower interest rates increases investment. Higher investment results in higher GDP.