Chapter 13

Question 1

How Can Monetary Policy Be Conducted?

Answer 1

Monetary policy can be conducted either by targeting the money supply or by targeting the interest rate, but both cannot be targeted independently due to the negatively sloped MD curve.

Question 2

Why Does the Bank of Canada Target the Interest Rate?

Answer 2

The Bank targets the interest rate because of its incomplete control over the money supply and uncertainty regarding the slope and position of the MD curve.

Question 3

What is the Bank of Canada’s Target for the Overnight Interest Rate?

Answer 3

The Bank establishes a target for the overnight interest rate and controls it by offering to lend at a rate 25 basis points above this target (the bank rate) and to accept deposits at 25 basis points below the target.

Question 4

What are Expansionary and Contractionary Monetary Policies?

Answer 4

The Bank of Canada conducts expansionary monetary policy by reducing its target for the overnight interest rate and contractionary monetary policy by raising it.

Question 5

Why is High Inflation Damaging?

Answer 5

High inflation is damaging to economies and costly for individuals and firms.

Question 6

What Determines Sustained Inflation?

Answer 6

Sustained inflation is ultimately determined by monetary policy.

Question 7

What is the Bank of Canada’s Inflation Target?

Answer 7

The Bank of Canada aims to keep the annual CPI inflation rate close to 2 percent.

Question 8

How Does the Bank of Canada Stabilize the Economy?

Answer 8

The Bank stabilizes the economy by tightening policy during an inflationary gap and loosening it during a recessionary gap, keeping inflation near 2 percent.

Question 9

What Complicates Monetary Policy?

Answer 9

Volatile food and energy prices and changes in the exchange rate complicate the conduct of monetary policy.

Question 10

What Are the Lags in Monetary Policy?

Answer 10

Long and variable lags exist in monetary policy because it takes time for firms and households to change their expenditures and for the multiplier process to affect equilibrium national income.

Question 11

How Should the Bank Respond to Economic Shocks?

Answer 11

The Bank should respond only to significant and persistent shocks rather than trying to “fine-tune” the economy.

Question 12

What Was the Bank of Canada’s Policy in the Early 1980s?

Answer 12

The Bank of Canada implemented a tight money policy to reduce inflation, contributing to a severe recession.

Question 13

What Happened During the Economic Recovery from 1983 to 1987?

Answer 13

The Bank’s main challenge was to create sufficient liquidity to support recovery without triggering high inflation.

Question 14

What Policy Did the Bank Announce in 1988?

Answer 14

The Bank announced a long-term goal of “price stability,” aiming to reduce inflation to below 2 percent.

Question 15

What Controversy Arose from the Bank’s Tight Money Policy?

Answer 15

The controversy concerned whether the benefits of lower inflation were worth the cost of lost output and heavy unemployment, and whether the low inflation rate could be sustained.

Question 16

How Did the Bank Respond to the 2000-2001 Stock Market Declines and 9/11 Attacks?

Answer 16

The Bank of Canada and the U.S. Federal Reserve dramatically reduced their policy interest rates to prevent a recession.

Question 17

What Challenges Did the Bank Face Between 2002-2005?

Answer 17

The Bank dealt with the substantial appreciation of the Canadian dollar and increased its target for the overnight interest rate by two percentage points by 2006.

Question 18

How Did the Bank Respond to the 2008 Financial Crisis?

Answer 18

The Bank implemented policies to restore the flow of credit and reduced interest rates.

Question 19

What Happened During the Economic Recovery Leading to 2019?

Answer 19

Canadian real GDP reached or exceeded its potential level, and the Bank’s target for the overnight interest rate increased to 1.75 percent.

Question 20

How Did the Bank Respond to the COVID-19 Pandemic?

Answer 20

The Bank cut its policy interest rate to 0.25 percent and implemented quantitative easing (QE), increasing its total assets by approximately 400 percent.

Question 21

What is the Difference Between the Overnight Interest Rate and the Target Overnight Interest Rate?

Answer 21

The overnight interest rate is the actual rate at which banks lend to each other overnight. The target overnight interest rate is the rate set by the Bank of Canada as a goal for the actual overnight rate.

Question 22

What is the Bank Rate?

Answer 22

The bank rate is the rate at which the Bank of Canada lends to financial institutions, set 25 basis points above the target overnight interest rate.

Question 23

What is the Endogenous Money Supply?

Answer 23

The endogenous money supply refers to the idea that the supply of money in the economy is determined by the demand for loans and the behavior of banks and borrowers.

Question 24

What are Open-Market Operations?

Answer 24

Open-market operations are the buying and selling of government securities by the central bank to control the money supply and interest rates.

Question 25

What is the Difference Between CPI Inflation and Core Inflation?

Answer 25

CPI inflation includes all items in the consumer price index, while core inflation excludes volatile items such as food and energy prices to provide a clearer view of underlying inflation trends.

Question 26

How Does the Exchange Rate Affect Monetary Policy?

Answer 26

Changes in the exchange rate influence import and export prices, affecting inflation and economic activity, and thus impacting monetary policy decisions.

Question 27

What Are the Lags in the Effect of Monetary Policy?

Answer 27

Lags in monetary policy effects include the time it takes for interest rate changes to affect spending and for those changes to influence overall economic activity through the multiplier process.