During the COVID-19 pandemic, many firms had to curtail their production and lay off workers. This reduced production capacity as well as incomes, which means that both supply and demand went down. However, the deflation observed in during March-May 2020 despite fiscal and monetary stimuli suggests that aggregate demand (as determined by the crossing point of IS and LM curves) must have gone down more than the production capacity did. We want to understand how the rise of uncertainty and the current limitations on purchases of goods and services may, in the short run, contribute to the reduction of the aggregate demand in this situation. We also want to explore the implications of these factors for the future trends in the economy after the pandemic is over.

(a)First, let us see what has happened to the U.S. personal savings rate since the COVID-19 outbreak in early 2020. Please search the Federal Reserve Bank of St. Louis FRED data mart, https://fred.stlouisfed.org/ and report what you find about the trends in personal savings rate since February 2020 compared to earlier months. What does this data tell you about the households' behaviors when it comes to consumption and saving in Spring 2020? Could the rise in uncertainty and unavailability of some goods and services help explain at least part of this change in the saving and consumption pattern? Please explain your answer.

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(b)Many people who would have wanted to go to restaurants or take vacations away from home have been unable to do so. This is true of many other activities. What impact are these restrictions likely to have on the future expenditure plans of households?

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(c)To diminish the negative economic effects of the pandemic, the government and the central bank have pursued strongly expansionary fiscal and monetary policies, including substantial transfers to households. What is likely to be the impact of these policies on total household savings? Are all households impacted in the same way, or are some households likely to use these transfers differently, and why? What is the impact on public savings?

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(d)Suppose that everyone expects the pandemic situation to be resolved by next year, and the production capacity of the economy to be restored to its original level at the start of 2020. Also, assume that everyone expects the policy interventions in 2020 and 2021 to be such that in 2021 the IS and LM curves return to their positions at the start of 2020. Now, if the government decides to increase its expenditures this year more than what everyone expects, what impact might it have on inflation next year, based on the IS-LM model? Why? Please explain your logic.

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