Question

het can contain viruses. Unless you need to edit, it's safer to stay in Protected View. Enable Editing ............2...3...4...5... Ch 5 Fig. 7.1 p. 121 Most Recent Complete Canadian Business Cycle 1700 Real GDP Inflationary Gap (1) You are hero Recessionary Gap 1600 Expansion Contraction 1500 Expansion Trough h Contraction and Recession 1400 Real GDP Q1 Q4Q1 Q4 Potential GDP ol 2005 2006 2007 2008 2009 2010 2011 Year 2015 Pearson Canada Inc. Chapter 11 Side 2 D Focus 00 e N W

Given the conditions described on page 1;

1. In this situation, what does the Bank of Canada want to motivate? What action does the Bank of Canada take? (Consider: Interest rates, bonds, value of Canadian investments, Canadian $ exchange rate)

1. What effect does this have on the R.O.W. and what will they do?

(Consider: Canadian $ Exchange rate, buying Canadian products)

1. What effect does this have on Canadian Consumers and what will they do?

(Consider: Canadian $ Exchange rate, buying R.O.W. products)

1. What effect does this have on GDP, Unemployment, and the Rate of Inflation?

Answer 1

A. As it is given in the question that we are in inflationary gap and the economy is operating beyond potential GDP. Therefore Canadian Central bank will need to reduce interest rate in order to combat inflationary pressures and bring economy down to potential GDP.

Therefore,

Interest rate will increase due to central bank's actions.

Price of bonds will decrease due to interest rates going up, remember bond price and interest rates moves in opposite direction.

Value of Canadian investments will fall because of higher interest rates.

Canadian Exchange rates will rise, because increase in interest rates will lead to capital inflows because of getting higher real return. Therefore value of Canadian dollar (CAD) will rise.

B. Due to increase in CAD value and depreciation of other currencies, it will become costly for ROW to buy goods from Canada, therefore this will lead to less demand for Canadian products.

C. Due to increase in CAD value and depreciation of other currencies, it will become cheap for canadian consumers to buy goods from ROW, therefore this will lead to increase in demand for ROW products in Canada.

D.

GDP will fall because of interest rates increase, investment will reduce and exports will drop due to CAD appreaciation. Both of them will result in lowering of GDP to Potential GDP.

Unemployment in Canada will increase because of decreasing investments and drop in exports, firm's will try to maintain margins by laying off employees.

Rate of Inflation will reduce because of central bank's decision to increase interest rates.

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