Suppose that Canada is now in a recession triggered by the COVID-19 pandemic, with unemploy-ment and an output gap. We now analyze this situation using a New Keynesian sticky price modelthat we learned in Chapter 14. In particular, the labor market and the goods market do not haveto clear in the New Keynesian model. Note: In this question, you do not need to show how theCOVID-19 pandemic affects the economy, i.e., you do not need to compare the economy before andafter the COVID-19 shock. Instead, you directly start from the fact that the economy is currentlyin a recession with unemployment.

1. Draw four separate figures illustrating the labor market, the goods market, themoney market, and the production function. Make sure you illustrate clearly that there isunemployment in the economy, and label clearly the output gap in the figure of the goodsmarket.

2. To help the economy recover from the recession, the Bank of Canada has cutthe policy interest rate to 0.25%. At the same time, the government expenditure increases:The Government of Canada announced the COVID-19 Economic Response Plan will provideup to $27 billion in direct support to Canadian workers and businesses. Use the four figuresto analyze how this combination of expansionary fiscal policy and expansionary monetarypolicy together helps the economy recover from the current recession by showing its impactson output, employment, interest rate, wage, and money demand. (Hint: In our lecture noteswe analyze the effects of fiscal policy or monetary policy separately, while in this question youare asked to illustrate the effects of these two policies that are implemented simultaneously.)