Question

How Covid-19 has affected the global economy

According to IMF, the global economy is expected to shrink by over 3 per cent in 2020 – the steepest slowdown since the Great Depression of the 1930s.

Amid the coronavirus pandemic, several countries across the world resorted to lockdowns to “flatten the curve” of the infection. These lockdowns meant confining millions of citizens to their homes, shutting down businesses and ceasing almost all economic activity. According to the International Monetary Fund (IMF), the global economy is expected to shrink by over 3 per cent in 2020 – the steepest slowdown since the Great Depression of the 1930s.

Other things remaining the constant, if the annual income of the world get decrease in 2020 than what will be the impact of money demand and interest rate? Draw the Money market and LM diagram and explain your answer.

Draw the appropriate diagram and explain movements along the LM curve and shift of LM curve.

Answer 1

A decrease in income will decrease the (transactions) demand for money, shifting money demand curve leftward. As a result, interest rate will decrease.

In following graph, MD0 and MS0 are initial money demand and supply curves, intersecting at point A with initial interest rate r0 and quantity of money M0. When money demand decreases, MD0 shifts left to MD1, intersecting MS0 at point B with lower interest rate r1.

Decrease in income will reduce consumption and investment, shifting IS curve leftward, decreasing interest rate and decreasing output. Lower demand for money will shift the LM curve rightward, decreasing interest rate and increasing output. The net effect is a definite decrease in interest rate, but effect on output is uncertain.

In following graph, IS0 and LM0 are initial IS and LM curves intersecting at point A with initial interest rate r0 and output Y0. When income decreases, IS0 shifts left to IS1, and when money demand decreases, LM0 shifts right to LM1, intersecting IS1 at point B with lower interest rate r1 and new output Y1.