13.4 Four Decades of Canadian Monetary Policy Flashcards
What significant economic events occured in 1973 and 199-1980?
The OPEC oil-price shocks of 1973 and 1979–1980 led to reductions in GDP growth rates and increases in inflation in Canada—what came to be known as stagflation.
In the standard AD/AS diagram, the increase in oil prices led to a leftward shift of the AS curve.
At that time, the role of aggregate-supply shocks and their effect on macroeconomic equilibrium was not as well understood as it is today.
The Bank of Canada’s policy response involved considerable monetary expansion, which shifted the AD curve to the right. By 1980 the rate of inflation in Canada was more than 12 percent.
What was the Bank of Canada’s responce to the OPEC oik-price shocks?
The Bank of Canada then embarked on policies designed to reduce the growth rate of the money supply and eventually reduce the inflation rate.
Unfortunately, at the same time innovations in the financial sector led to unexpected increases in the demand for money.
The result was a much sharper increase in interest rates (see Figure 13-6) than was intended by the Bank of Canada and the most serious recession since the 1930s. But the rate of inflation did fall, from more than 12 percent in 1980 to about 4 percent in 1984.
What were the two important lessons learned from the OPEC oil-price shocks?
- Monetary policy can be very effective in reducing inflation.
- Because of unexpected changes in money demand, monetary policy should focus more on interest rates than on the money supply.
The Second lesson is an important reason why the Bank now implements its policy by targeting a short-term interest rate rather than by directly targeting the money supply.
What were the main challenges for the BoC during the period of Economic recovery during 1983 - 1987?
The main challenge for monetary policy in this period was to create sufficient liquidity to accommodate the recovery without triggering a return to the high inflation rates that prevailed at the start of the decade.
In other words, the Bank of Canada had to increase the money supply to accommodate the recovery-induced increase in money demand without increasing the money supply so much that it refuelled inflationary pressures.
How did the BoC respond to the challenges during the Economic recovery period of 1983 - 1987?
The Bank allowed a short but rapid burst of growth in the nominal money supply, intended to accommodate the rise of money demand accompanying the recovery. It then reduced the growth rate of the money supply to a rate consistent with low inflation and the underlying growth in real income.
The trick with this policy was that to avoid triggering expectations of renewed inflation, the Bank had to generate a one-shot increase in the level of the money supply without creating the expectation that it was raising the long-term rate of growth of the money supply.
What were the main concerns of Rising inflation between 1987 - 1990?
By mid-1987, observers began to worry that Canadian policymakers were too complacent in accepting the 4 percent range into which Canadian inflation had settled.
Further, there was concern that inflationary pressures were starting to build—the money supply was growing quickly, real output growth was strong, unemployment was falling, and an inflationary gap was opening.
Many economists argued that if monetary policy was not tightened, Canada would experience gradually increasing inflation until once again a severe monetary tightening would be required to reduce the rate of inflation.
In 1988, What did Governor John Crow annouce reguarding monetary policy?
In January 1988, Bank of Canada Governor John Crow announced that monetary policy would thenceforth be guided by the goal of achieving long-term “price stability.” Specifically, he said that “monetary policy should be conducted so as to achieve a pace of monetary expansion that promotes stability in the value of money. This means pursuing a policy aimed at achieving and maintaining stable prices.”
Dispite the banks explicit policy of price stability, what was the change in inflation rate between 1987 and 1990?
Despite the Bank’s explicit policy of “price stability,” the actual inflation rate increased slightly from about 4 percent in 1987 to just over 5 percent in 1990.
What resulted from the high interest rates in 1990?
The high Canadian interest rates attracted foreign financial capital. Foreigners who wanted to buy Canadian bonds needed Canadian dollars, and their demands led to an appreciation of the Canadian dollar.
This increased the price of Canadian exports while reducing the price of Canadian imports, putting Canadian export and import-competing industries at a competitive disadvantage and further increasing the unemployment that had been generated by the worldwide recession.
What did the Government of Canada and the BoC announce in 1991?
In 1991, the Government of Canada and the Bank of Canada formally announced inflation-control targets for the next several years.
Beginning in 1992, the Bank would attempt to keep inflation within the 3 to 5 percent range, with the range falling to 2 to 4 percent by 1993 and to 1 to 3 percent by the end of 1995.
What happened to the inflation rate between 1990 and 1994?
The inflation rate fell sharply, from about 5 percent in 1990 to less than 2 percent in 1992. For 1993 and 1994, inflation hovered around 2 percent.
What happened to short-term nominal interest rates between 1990 and 1993?
Short-term nominal interest rates fell from a high of about 13 percent in 1990 to about 6 percent by the end of 1993.
Recall that the nominal interest rate is equal to the real interest rate plus the rate of inflation. So this decline in nominal interest rates was the eventual result of the tight monetary policy that reduced inflation.
Despite the success in reducing inflation, controversy continued on two issues. (1990 - 1993)
First, was the result worth the price of a deeper, possibly more prolonged recession than might have occurred if the Bank had been willing to accept slightly higher inflation?
Second, would the low inflation rate be sustainable once the recovery took the economy back toward potential output?
In 1994, at the end of Crow’s seven-year term, the minister of finance appointed Gordon Thiessen, the former senior deputy governor of the Bank, to be the new governor. What happened after?
With some irony, the minister of finance, whose party had been severe critics of Crow’s policy while they were in opposition, affirmed the previous monetary policy of the Bank and urged the new governor to maintain the hard-won low inflation rate. The new governor agreed, and the formal inflation target of 2 percent was extended until 2001.
