Assignment Economics

Section A

1. Answer: B- Companies take time to increase production during early recovery as they want to
confirm that recession is really over and also need to adjust after downsizing during recession.
2. Answer: A – Because many household finance house buying/ construction with a mortgage.
3. Answer: C
4. Answer: C
5. Answer: B
6. Answer: C
7. Answer: B
8. Answer: B
9. Answer: B
10. Answer: B

Section B

(a) Canada

From the data provided we note that Canada projected GDP growth rate is 4% and potential growth
rate is 2.6%. The difference between the two is the output gap which plays a central role in
policymaking. In this case, we may say that the country is in a boom situation as output is rising
above its potential level, thus resulting in a positive gap. We can thus described the economy as
“overheating, “thus generating upward pressure on inflation. This may give a signal to the central
bank to “cool” the economy by raising interest rates.

(b) Germany

The difference between the actual GDP growth and the potential GDP growth is negative which
mean that the economic output drops below its potential, which creates a negative output gap. In
this case the Central Bank may adopt a monetary policy to stimulate economic growth i.e by
lowering interest rates, so as to boost demand and prevent inflation from falling below the central
bank’s inflation rate target.

(c) Japan

Since the difference between the actual and potential GDP growth is positive and in order to sustain the
expansionary economic policy, the Central Bank of Japan should perhaps decrease further the interest
rates so as to continue to boost up the economy.

(d) USA
 In this case, I think the interest rate should remain unchanged as the economic growth is
relatively stable and even if the difference between the actual and potential GDP is positive, by
further decreasing the interest rates the economy will grow too fast thus creating an inflationary
gap.

(e) Bond market participants may reduce their demand for long term bonds so as to push up their
yields if they believe that the monetary authority is not doing enough for inflation and may push
long term rates down by increase demand for bonds if they expect that tight monetary policy is
likely to cause a sharp slowdown in the economy. Therefore I believe that the bond prices will
rise in USA which has the positive and stable economic growth.