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Explain and use an AS/AD diagram and a demand/supply diagram for the Canadian dollar to illustrate...

Explain and use an AS/AD diagram and a demand/supply diagram for the Canadian dollar to illustrate how the Bank of Canada can eliminate an inflationary gap with monetary policy. Note in the AS/AD diagram you do not need to draw the multiplied (AD +/- ∆E) aggregate demand curve. Be sure to address the impact of monetary policy on all components of AD except for G.


Explain and use an AS/AD diagram and a demand/supply diagram for the Canadian dollar to illustrate how the Bank of Canada can eliminate a recessionary gap with monetary policy. Note in the AS/AD diagram you do not need to draw the multiplied (AD +/- ∆E) aggregate demand curve. Be sure to address the impact of monetary policy on all components of AD except for G.

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Answer #2

a) suppose the goods market is initally at e where output is Y and equilibrium price is P. There is an inflationary gap because current gdp Y is greater than Y*

To eliminate inflationary gap bank of Canada implements contractionary monetary policy, that is decreases money supply in the economy. Decrease in money supply increases the interest rate. higher interest rate leads to decrease investment spending which is the component of aggregate demand. This leads to leftward shift in AD to AD'. New equilibrium is reached at e'where output has decreased back to Y* and price level has fallen to P'.

Decrease in money supply shifts the S curve to the left. Exchange rate has increased to E' with lower level of quanity of Canadian dollars.

answered by: anonymous
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