Answer to Question #309615 in Macroeconomics for charles alexis

Question

1. The Global Insight (GI) forecasting firm predicted that the Canadian economy would bounce back by a stronger-than-expected 1.0 percent on an annualized basis in the third quarter of 2012 and with a further 0.1 percent in the fourth quarter of 2012. The firm also expected moderate growth overall in 2013.

(10 marks)

a.      What evidence did GI present to support the view that Canada had entered a recovery?

(2 marks)

b.     Use a short-run Phillips curve to explain why the inflation rate may have increased over the course of 2012.

(4 marks)

c.      Under what circumstances might the inflation rate not have increased during 2012?

(4 

Answer 1

a. What evidence did GI present to support the view that Canada had entered a recovery?

According to the evidence presented by Global Insight, the Canadian economy has been exhibiting signs of growth, with the components that make up GDP, such as exports, investments, and so on, all increasing and projected to continue to expand in the near future.

If Canada does not see a full-fledged inflationary gap in 2013, moderate growth suggests that it will be near to full employment and functioning well. Furthermore, the data shown here pertains to real GDP, which is rising.

b. Use a short-run Phillips curve to explain why the inflation rate may have increased over the course of 2012.

The relationship between unemployment and inflation is known as the Phillips curve.

As the unemployment rate declined in 2012, inflation may have increased. If the economy is performing well and there is a lot of spending going on, more people will be able to find jobs. As a result, unemployment has decreased and more people are employed. As the unemployment rate declines and more individuals find work, people with jobs have more discretionary cash to spend.

It's also likely that net exports and investment may increase. A rise in aggregate demand and aggregate investment leads to an increase in real GDP and inflation. There is a leftward shift along the short-run Phillips curve as follows:

We can see in Graph 1.1 that point 1 has a current unemployment rate of 6% and a current inflation rate of 4%. At point 2, the unemployment rate drops to 3%, while inflation jumps to 6%.

c. Under what circumstances might the inflation rate not have increased during 2012?

The inflation rate would not have risen in 2012 if employment levels had remained low. In this case, people will not have additional discretionary income to spend, forcing GDP and price levels to grow. When unemployment decreases, inflation rises steadily. The inflation rate would not have increased in 2012 if unemployment had stayed steady or risen.

When an economy transitions from a recessionary period to one of expansion, it is moving in the direction of inflation in the business cycle. Furthermore, the government or the Bank of Canada may have established a fiscal policy or a monetary policy to limit inflation from getting too high. However, the economic cycle is also to blame, and unemployment may have grown as well if inflation had not risen in 2012.