THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 581

PA R T V I I

Monetary Theory

Chapter 21 The Demand for Money
Chapter 22 The ISLM Model
Chapter 23 Monetary and Fiscal Policy in the ISLM Model
Chapter 24 Aggregate Demand and Supply Analysis
Chapter 25 Transmission Mechanisms of Monetary Policy: The Evidence
Chapter 26 Money and Inflation
Chapter 27 Rational Expectations: Implications for Policy

CRISI S AN D RESP O NSE : T HE PE RFE CT STO RM
OF ADV ERSE S HOC KS
In 2007 and 2008, the Canadian economy was hit by a perfect storm of formidable shocks. Higher demand for oil from rapidly growing developing countries like
China and India and slowing of production in places like Mexico, Russia, and
Nigeria drove up oil prices sharply from around the US$60 per barrel level at the
beginning of 2007. By the end of the year, oil prices had risen to US$100 per barrel and reached a peak of over US$140 in July of 2008. The oil price shock was
both contractionary and inflationary, and as a result led to both higher inflation
and unemployment and many unhappy drivers at gas pumps.
If this supply shock were not bad enough, the subprime financial crisis in the
United States hit the world economy starting in August of 2007 and caused a contraction in both household and business spending. This shock led to a further rise
in unemployment, with some weakening of inflationary pressure further down the
road.
The result of this perfect storm of adverse shocks was a rise in unemployment
from the 6% level in 2006 and 2007 to over 8% by the beginning of 2009. Inflation
also accelerated from 2.6% in 2007 to over 5% by the middle of 2008, but with the
increase in the unemployment rate and the decline of oil and other commodity
prices by the beginning of 2009, inflation rapidly came back down again.
Although the Bank of Canada s aggressive monetary policy aimed to address
the contractionary forces in the economy, the government of Canada also took

action in a coordinated response to the global financial crisis with the Group of 20
(G20) countries. Although this policy response helped stimulate household spending, it was overwhelmed by the continued worsening of the financial crisis, and
the economy went into a tailspin.
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