Many commentators have predicted that the Covid-19 pandemic will lead to a deep recession

in Canada as measures such as social isolating cause sharp declines in consumer spending.

Policymakers in Canada have responded by implementing a number of measures designed to

try to limit the extent of the recession. In this exam you look at the short-run eects of the

pandemic and the policy responses in the context of the Aggregate Supply and Aggregate

Demand (AS-AD) model.

Throughout this exam assume that Canada is a small open economy with perfect capital

mobility and a flexible exchange rate. You may also assume that expected inflation is equal

to zero.

Parts:

1. Using the AS-AD model show the impact of the decline in consumer spending on

output, the price level and the interest rate in the short-run. You may assume that

with Covid-19 being a global pandemic that the world interest rate has fallen. Use a

diagram and make sure that you give a detailed explanation of the economic reasoning

behind the change in each variable.

2. Canada has initiated a number of policies aimed to support the income of Canadians

during this crisis, such as tax deferrals and the Canada Emergency Response Benet.

Assuming that these policies work the same way as a tax cut in the AS-AD model, what

is the predicted eect of these policies on income, the price level and the interest rate?

For this part assume that the world interest rate is unchanged from its level in part

1 and that there is no change in the money supply in Canada. Again, use diagram(s)

and be sure to give a detailed explanation of the economic reasoning behind the change

in each variable.

3. At the same time as the policies in part 2 were initiated the Bank of Canada cut its

overnight rate from 1.75% to 0.25% and began purchasing government and corporate

debt. Explain how each of these two actions would have led to an increase in the money

supply in Canada.

4. How would this expansionary monetary policy change your answer to part 2? Again,

use diagram(s) and be sure to give a detailed explanation of the economic reasoning

behind the change in each variable.

5. In addition to the policies described in part 2, the Canadian government is also oering

a 75% wage subsidy to small and medium businesses. Predict the impact of this policy

on income, the price level and the interest rate using the AS-AD model. Use a diagram

and make sure that you give a detailed explanation of the economic reasoning behind

the change in each variable.