In the summer of 2006, a time when U.S inflation was rising and output was above
ID: 1098037 • Letter: I
Question
In the summer of 2006, a time when U.S inflation was rising and output was above potential, a story in the Globe and Mail reported that the release of strong employment-growth data for the United States led to a plunge in prices on the U.S. stock market.
A) Explain why high employment growth would lead people to expect the U.S. central bank to tighten its monetary policy.
B) Explain why higher U.S. interest rates would lead to lower prices of U.S. stocks.
C) How would you expect this announcement to affect Canada?
Explanation / Answer
a
According to Phillips Curve that is a tradeoff between Inflation and Unemployment.It shows that unemployment is inversely related to inflation i.e. If unemployment decrease the inflation will increase..Thus from here we can conclude that high employment growth would lead people to expect the U.S. central bank to tighten its monetary policy.
b
As the Interest rate rise the yield on the bond's rise too such that the bond's price fall.Thus making bond a profitable investment.Thus there will be a shift of investors from stock market to bond market and thus the U.S. stocks fall if US interest rate rises
c
As central bank tightens the monetary policy, thus the US dollar becomes more valuable against other currencies.Thus The Canadian dollar price will rise against 1 US dollar. To Canandian people investing in US there will be a higher profits due to high currency exchange income. For Rest of the Canadian people their money has depriciated in face of US currency thus they bear a loss for any imports from US.