Question

The question addresses the short-run effects of financial shocks and policy responses on the overall economic performance of an open economy. They refer to the length of run over which the productive capital stock is fixed, determined by previous investment. New investment creates expenditure on current GDP but does not affect current production capacity. External factor income flows net out at zero.

The economic shocks due to the current pandemic began with a supply-side contraction: businesses closed their doors and laid-off workers, leading to significant reductions in output and income. Use what means of analysis is at your disposal to explain what the consequences of such a shock are for financial and economic performance in the short run. Then consider the shock to be exacerbated by pessimism about the future, with government responses taking the form of debt-financed transfers. Explain some possible implications of this for financial market behavior during the recovery.

Answer 1

Such contraction of markets ans upply shocks have huge impacts on the economy. Wwith the situation given at hand when the government has to drastically spend money to stimulate the economy leading to a higher level of fiscal deficits than what was projected leading to government taking debts to fulfill its obligations. firms which are facing cash shortages or low demand will take loans at lower interest rates from the banks. Consumer will be willing to spend less and save more due to uncertainity about jobs and saving money for some emergency situations. This will make the stimulations and full functioning in the economy at the normal levels take quite some time. Also the huge burden of debt on the government will not be easy to pay as recovery from revenue sources will be very less especially from tax revenues as well bearing cost of providing loan moratariums, reducing lending rates and thus most of its debt payment of which interest will form the most part will be paid for which government might need to increase taxes which will make it more unsure for the suppliers to produce and they will pass on their debt burden on the end consumers. Thus, this vicious circe will take quite some time to break so that economy can return back to normal levels of activity.