Given the higher fully vaccinated rates in the United States, it's likely that the American economy will recover quicker than Canada's. With the risks of an overheating economy on the other side of the Covid recession, the Federal Reserve may need to raise its key interest rate if inflation overshoots the 2% target.

a) What is the central bank's interest rate for? What other rates that might matter to you are correlated with it? Why are they correlated with it? (2)

b) Why would it make sense to use a Taylor Rule here for interest rate decision-making? (2)

c) At the same time, the head of the Bank of Canada, Tiff Macklem was quoted as saying "Interest rates are very low and they are going to be there for a long time [...] Canadians and Canadian businesses are facing an unusual amount of uncertainty, so we have been unusually clear about the future path for interest rates." which observers took to mean that rates will not rise until 2023. Is this a hawkish or dovish position from Macklem? Explain (2)

d) If the Federal Reserve raises rates before 2023, and Canada does not raise its Bank Rate, what will happen to the value of the Canadian dollar and what impact will that have on the Canadian economy? (2)

e) Explain how the Marginal Propensity to Consume affects the fiscal spending multiplier. Is it possible for expectations about future tax increases/decreases to affect the multiplier? (3)