Q.Start with the situation reflecting the pandemic crisis which hit the Canadian economy in early Spring 2020.

(i) the government ordered several businesses to stop or restrict operations (lockdown),

(ii) due to fear of contagion, households have avoided some businesses which continued operating, including going to work. Assume the effects on labor demand and aggregate output demand are dominant. Suppose now that prices are sticky, and output is demand-determined.

(a)In response to the pandemic crisis, government debt has increased significantly in Canada (and all over the world). The associated increase in the supply of government bonds would normally have led to an increase in real interest rates, however the Bank of Canada has managed to keep interest rates low.

(b)Fiscal policy can be a very powerful tool for macroeconomic stabiliza- tion in a small open economy under sticky prices, provided the monetary authority commits to intervening in foreign exchange markets to stabilize the value of the domestic currency. In this case the equilibrium output fiscal multiplier is equal to 1.

(c) We have witnessed a re-emergence of fiscal policy as a major tool for macroeconomic stabilization following the 2008-9 financial crisis. This can be explained by the fact that interest rates have been declining over time, reaching all time lows around this period. Open market purchases are ineffective in this scenario, whereas fiscal expansion works.