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E1010 > Chapter 11|Monetary Policy and the Bank of Canada > Flashcards

Chapter 11|Monetary Policy and the Bank of Canada Flashcards

1
Q

Bank of Canada’s Job

A

The bank of Canada changes the money supply and interest rates, aiming for an inflation control target that achieves steady growth, full employment, and stable prices.

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2
Q

The Bank of Canada is responsible for

A

monetary policy

Price Stability

Inflation-control target

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3
Q

monetary policy

A

Adjusting the supply of money and interest rates to achieve steady growth, full employment, and price stability.

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4
Q

Price Stability

A

means inflation rate is low enough to not significantly affect peoples’ decisions

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5
Q

Inflation-control target

A

range of inflation rates set by a central bank as a monetary policy objective

  • Bank of Canada’s target is an annual inflation rate of 1 to 3 percent as measured by the CPI
  • Monetary policy aims for 2 percent
  • Bank of Canada uses core CPI as an operational guide about underlying inflation trends
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6
Q

Open Market Operations

A

The Bank of Canada uses open market operations to change interest rates. Buying bonds increases the money supply and raises bond prices, lowering interest rates. Selling bonds decreases the money supply and lowers bond prices, raising interest rates.

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7
Q

Interest rates are determined in

A

money and loanable funds (bond) markets

  • Central banks influence short-run interest rates, but not long-run interest rates
  • Bank of Canada’s main policy tool is the overnight rate – interest rate banks charge each other for one-day loans.
  • Overnight rate determines all other short-run interest rates
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8
Q

Lower interest rates →

A

↑borrowing and spending, ↓saving

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9
Q

In a recessionary gap

A

Bank of Canada lowers interest rates to increase aggregate demand and accelerate the economy

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10
Q

Higher interest rates →

A

↓borrowing and spending, ↑saving

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11
Q

In an inflationary gap

A

Bank of Canada raises interest rates to decrease aggregate demand and slow down the economy

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12
Q

Bank of Canada changes the target interest rate through open market operations

A

Buying or selling government bonds on bond market
Money and bond markets are interconnected

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13
Q

To lower interest rates and accelerate economy

A

Money market story

Bond Market Story

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14
Q

To lower interest rates and accelerate economy

Money market story

A

BoC changes money supply using open market operations to influence quantity of demand deposits (part of M1+)

  • Bank of Canada buys bonds, increasing bank reserves, loans, demand deposits, money supply
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15
Q

To lower interest rates and accelerate economy

Bond Market Story

A

BoC changes money supply using open market operations to influence bond prices and interest rates

  • Bank of Canada buys bonds, demand for bonds increases, raising bond prices, lowering interest rates
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16
Q

To raise interest rates and slow down economy

Bond Market Story

A

BoC changes money supply using open market operations to influence bond prices and interest rates

  • Bank of Canada sells bonds, supply of bonds increases, lowering bond prices, raising interest rates
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17
Q

To raise interest rates and slow down economy

Money market story

A

BoC changes money supply using open market operations to influence quantity of demand deposits (part of M1+)

  • Bank of Canada sells bonds, decreasing bank reserves loans, demand deposits, money supply
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18
Q

When Bank of Canada changes overnight rate

A

most short-run interest rates change in same direction

Prime Rate

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19
Q

Prime Rate

A

interest rate on loans to lowest-risk borrowers

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20
Q

Long-run interest rates determined in the loanable funds (bond) market

A

Long-run interest rates determined in the loanable funds (bond) market

21
Q

Transmission Mechanisms

A

Monetary policy affects aggregate demand by reinforcing domestic and international transmission mechanisms connecting interest rates, exchange rates, and spending.

22
Q

Open market operations and interest rates affect aggregate demand (C + I + G + X - IM) through

A

Domestic monetary transmission mechanism (red paths)
International transmission mechanisms (blue paths)

(IMAGE ON GOOGLE DOC RIP)

23
Q

Domestic monetary transmission mechanism

A

Lower interest rates a positive aggregate demand shock, increasing consumption (C) and business investment spending (I)

Higher interest rates a negative aggregate demand shock, decreasing consumption (C) and business investment spending (I)

24
Q

International transmission mechanisms work through impact of interest rates on exchange rate

A

Lower interest rate -> depreciating C$; positive demand shock increasing net exports (X - IM) increasing inflation

Higher interest rate - appreciating C$; negative demand shock decreasing net exports (X - IM), decreasing inflation

25
Q

Domestic and international transmission mechanisms reinforce each other

A

Domestic and international transmission mechanisms reinforce each other

26
Q

Use monetary policy to correct recessionary gap by lowering interest rates

A

– -> aggregate demand increases, unemployment decreases, inflation increases

27
Q

Use monetary policy to correct inflationary gap by raising interest rates

A

– -> aggregate demand decreases, unemployment increases to natural rate, inflation decreases

28
Q

Monetary policy is about moderation

A

accelerating when economy is slowing, braking when economy is speeding up

Monetary policy to brake the economy is politically unpopular

28
Q

Transmission Breakdowns

A

In a balance sheet recession, individuals and businesses focus on paying down debt and do not want to borrow or spend. Even when monetary policy lowers interest rates, the economy remains in recession.

28
Q

Recessions often start with

A

Decreasing business investment spending, falling net exports, or rising interest rates

29
Q

2008 Global Financial Crisis instead started with falling asset prices

A

-> a balance sheet recession

30
Q

Balance sheet shows assets

A

(what you own or earn) and debts or liabilities (what you owe or spend)

-Falling asset prices led individuals and businesses to cut spending, save, and pay down debt

-Transmission breakdowns for monetary policy:↓ interest rates did not ↑ spending or aggregate demand

31
Q

Transmission breakdowns are caused by

A

Consumers - saving more, paying off debts, and spending less

Businesses - pessimistic expectations decrease business investment spending even with lower interest rates

Money as a store of value – giving players a way not to spend

Banks – holding cash reserves and not making new loans and not increasing demand deposits and money supply

32
Q

To counteract transmission breakdowns, central banks used

A

quantitative easing

33
Q

quantitative easing

A

flooding the financial system with money by buying high-risk bonds, mortgages, and assets from banks

Liabilities on bank balance sheets replaced with cash, enabling banks to make new loans, new demand deposits, and increase quantity of money

34
Q

Risk of inflation from flooding financial system with money

A

Quantity theory of money predicts increasing money supply causes inflation

Central banks have a difficult timing problem of applying monetary “brake” of higher interest rates before inflation starts, but not too soon to stop economic recovery

Balance sheet recessions cause transmission problems for monetary policy, making it harder to steer economy toward recovery

35
Q

Inflation Expectations

A

Inflation rate targeting by an independent central bank anchors inflation expectations, helps price signals work, and combines a hands-off emphasis on rules and hands-on emphasis on government discretion.

36
Q

Inflation-control target set jointly by Government of Canada and Bank of Canada

A

Bank of Canada alone responsible for monetary policy to achieve the target
Bank of Canada has considerable independence but ultimately responsible to Parliament

37
Q

Bank of Canada focused only on inflation rate since 1991

A

inflation stayed within the target range

Steered economy toward rising living standards, full employment

38
Q

Advantages of inflation rate targeting

A

Anchoring expectations about inflation

Improving predictability of prices

39
Q

Phillips Curve trade-off between inflation & unemployment works when expectations of inflation do not change

A

Once inflation starts, changing expectations self-fulfilling – reacting to expectation of inflation may cause it

Changing inflation expectations, with increases in money supply, eliminated original Phillips Curve’s trade-off between inflation and unemployment

40
Q

Inflation expectations go up quickly and easily, but come down slowly and painfully

A

Inflation expectations go up quickly and easily, but come down slowly and painfully

41
Q

Unpredictable prices – due to inflation – create risk, discourage business investment, interfere with price signals for smart choices

A

Unpredictable prices – due to inflation – create risk, discourage business investment, interfere with price signals for smart choices

42
Q

Yes – Markets Self Adjust – Hands Off and No – Markets Fail Often – Hands On camps agree _____

A

markets need a central bank

Banks regulated because of trade-off between profits and prudence

43
Q

What do Yes and No camps have disagreements on

A

Disagreements between camps on monetary policy

44
Q

Yes – Markets Self Adjust camp favours

A

hands-off rules for monetary policy, likes targets, no discretion for central bankers, no opportunity for politicians to influence monetary policy

Believes government failure is more likely than market failure

45
Q

No – Markets Fail Often camp favours

A

hands on government discretion for monetary policy to correct transmission breakdown, allow elected politicians to set policy

Believes market failure is more likely than government failure

46
Q

Both camps agree that inflation controls target are _____

A

effective compromise between hands-off emphasis on rules and hands-on emphasis on government discretion

E1010 (22 decks)

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