Problem: Energy costs are up in Canada and the rest of the world. Economic analysts see continued upward pressure on energy prices as the UN pushes for implementation of the Kyoto Accord on greenhouse gas emissions. With the aid of diagrams, answer the following questions.
(1) How would higher energy costs and the implementation of the Kyoto Accord (requiring investment in new pollution abatement equipment) affect equilibrium income, the price level, and the interest rate? (Assume pollution abatement alters only the cost structure.)
(2) Given (a) above, does it matter where the initial short-nm equilibrium was (i.e., Keynesian, intermediate, or classical range) prior to the increase in cost of energy and implementation of new pollution regulations? Explain.
(3) If the Bank of Canada implemented expansionary monetary policy in an attempt to exactly counter the effect in (a) above, what would happen to the aggregate demand curve, equilibrium income, and the price level?
(4) Can the use of monetary policy by the Bank of Canada counter the crowding-out effect? Explain.