Analyzing the impact of tax rebate on macroeconomic variables in a small open economy and a large open economy.
Canada is a small open economy and the U.S. is a large open economy. Currently, Canada is running a trade surplus with the U.S.
Use the long-run classical model of a small open economy to answer the following questions, and support each part of the question by a set of new diagrams (one for the loanable funds market and one for the foreign exchange market).
a) Recently, there are signals showing that there may be a slowdown of the U.S. economy. In attempt to avoid a potential recession, the U.S. government provides a tax rebate to all American households. What happens to the following variables:
National saving, trade balance, and price level in Canada
National saving and price level in the U.S.
Real exchange rate, eUS$/C$
Make sure to provide explanation on whether the values of variables of interest change or remain unchanged.
b) Now, instead of providing a tax rebate, in attempt to avoid the recession the Federal Reserve, the U.S. central bank, runs an expansionary monetary policy. Redo part (a).
c) Suppose the fiscal and monetary policies in the U.S. remain unchanged. The possible slowdown of the U.S. economy make Canadian households worry that Canada may experience also a slowdown; as a result, they save more and consume less. Redo part (a).