Suppose there is a recessionary gap and the Bank of Canada holds the money supply constant. This scenario will eventually lead to

Question

Quizplus · Accepted Answer

A recessionary gap means that aggregate demand is below potential output, which leads to lower output and employment in the short run. If the Bank of Canada holds the money supply constant, it means that interest rates will not change to stimulate investment and consumption, which will lead to a reduction in wages as businesses will have to lower costs to stay afloat. This will cause a downward shift of the AS curve in the short run. However, in the long run, the economy will adjust and potential output will decrease permanently as firms close down or reduce investment, leading to a lower level of output even if the AS curve shifts back to its original position.

Suppose There Is a Recessionary Gap and the Bank of Canada