Question
Question 4 - Using theory to understand the effects of and policy responses to the COVID-19 pandemic a) In the Phillip's curve-augmented IS-LM model, illustrate
Question 4 - Using theory to understand the effects of and policy
responses to the COVID-19 pandemic
a) In the Phillip's curve-augmented IS-LM model, illustrate the effects of the COVID-19 pandemic on equilibrium output, interest rate and inflation, assuming that the pandemic operates as a negative demand shock. Assume that the Central Bank does not intervene. Explain your findings.
b) Copy your graph from a) and add the IP curve, i.e., allowing for international trade and capital flows. Illustrate - in two separate figures - what would happen to equilibrium output, interest rate and inflation under (i) a fixed exchange rate and (ii) a floating exchange rate, respectively. Assume again that the Central Bank does not intervene actively. Explain your findings.
c) What economic policy would you suggest to speed up the economic recovery? In the respective set of graphs in b), illustrate your recommended policy action and its effects under (i) a fixed exchange rate and a (ii) floating exchange rate.
d) In a new set of graphs, illustrate the effect of the COVID-19 pandemic on equilibrium output, interest rate, inflation, and the exchange rate, assuming that the pandemic operates simultaneously as a negative demand shock and a disruption to supply chains (temporary cost shock). Assume that the exchange rate is floating. Is the outcome different from the corresponding case in b) (ii),
and if so, in what way?
e) What would be your policy recommendation based on the scenario described in d)?
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