Macro economy 

Question 1.   

Assume there is an increase in in the demand for money at every interest rate, with the use of an appropriate diagram, show what effect this will have on the equilibrium interest rate when money supply is constant. If the Bank of Canada is following a policy of targeting the overnight rate, explain what the Bank will have to do to keep the overnight rate at its initial level. Show this on your diagram and also on the balance sheets of the Bank of Canada and of commercial banks. 

Question 2.

Assume the economy is operating at potential.

• Suppose the world price of raw materials declines because of a decline in demand for these products. Canada is a net exporter of raw materials, what is the likely effect on Canadian aggregate demand? Explain. Show this in an AD/AS diagram. (Assume no change in the exchange rate) 
• Suppose instead there is a decrease in demand by foreigners for Canadian financial assets such as government bonds. On a new diagram, show the direct effect, if any, on Canadian aggregate demand. (Assume no change in the exchange rate) 
• Both shocks described above are likely to cause a depreciation of the Canadian dollar. As the Canadian dollar depreciates, what are the effects on aggregate demand in part (a) and in part (b)?  Shoe these "secondary" effects in your diagrams and explain. 

Explain why the appropriate monetary response to a change in the exchange rate depends on the cause of the cause of the exchange-rate change.