Question

The COVID-19 crisis has led to unprecedented shock to the state of the macroeconomy. Use the IS-LM curves as well as the AD-AS curves to show how the economy will correct itself if prices are sticky or sluggish. Compare this to how the economy will correct itself when we assume prices are flexible or adjust easily over the course of a year. In one or more paragraphs explain what should happen when the economy corrects itself under each scenario. Also, discuss the impact on all variables and economic agents. Be sure to indicate the direction of movement for all variables. (25 points)

Answer 1

Coronavirus has had huge impact on economic growth due to lockdown and shutdowns and social welfare losses.

The economic growth remains subdued as Aggregate demand and consumption both fall simultaneously also leading to fall in prices and inflation.

Investment is pumped out due to falling interest rate regime and lower economic outlook of companies.

Government spending is ramped up due to an expansionary fiscal policy by reducing taxes and spending. Also net exports go negative as imports surge due to supply shocks.

Negative growth in GDP causes high unemployment and lower inflation based on Philips curve movement.

Thus in short run, aggregate supply is high but aggregate demand is low and real GDP falls. However in long run the economy stabilises.

The US has been great in fiscal stimulus of 484 billion dollars and US Fed unlimited bonds buying programmes worth 2 trillion dollars with rate cuts, CRR and SLR and liquidity coverage ratio cuts. Triggering automotic stabilizers and combined above policy will help alleviates financial distress and grow economic growth throufh higher consumption and disposable incomes.

The supplyvof credit availability rises causing its demand to go down considerably.

Sijce the interest rates are cut, the banks shall transmit easier loans availability at lower rates and thus loan markets will grow enormously.

Despite price being sluggish there will be marginal decrease in orices causing deflation, also aggregate demand curves amd IS curve will shift leftwards due to slowdown in consumption causing recession.

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