Chapter 13 - Monetary Policy in Canada Flashcards
What are the approaches that any country’s central bank must keep in mind when implementing monetary policy?
1 - Target the money supply
2 - Target the interest rate
For a given M_D curve (money demand), both cannot be targeted independently. Both approaches will influence the other.
What is the target inflation rate for the Bank of Canada?
2% OR 1-3%
What is the difference between monetary policy and fiscal policy?
Monetary is managed by the central bank (Bank of Canada) and it aims to change money supply and interest rates.
Fiscal is managed by the governments and it aims to change taxation and government spending.
A reduction in the interest rate by monetary policy can be done directly or indirectly, explain each/give example.
Directly: Change (decrease) the ONR (overnight interest rate), which would cause the MS curve to shift right
Indirectly: Target the money supply. Since both the money supply and interest rate are not independent, targeting the money supply will also decrease the interest rate and shift the MS curve to the right.
So the same result was achieved in both cases.
If both approaches can arrive to the same result, why does it matter which approach is chosen?
The Bank of Canada chooses to conduct monetary policy by targeting its interest rate (instead of money supply) because it is more effective.
How is it more effective?
1 - Bank of Canada can control the interest rate (through the ONR). It can just set it.
2 - Bank of Canada can easily communicate its interest-rate policy decisions to the public.
3 - Targetting the money supply to indirectly affect the interest rate isnt efficient and requires some guess work given the uncertainty about the slope and position of the M_D curve.
What kind of transactions are labelled as open-market operations?
The purchase or sale of government securities on the open market by the central bank.
What’s an example of government securities and what’s the purpose of open-market operations?
An example is bonds. And Central bank engages in ope-market operations to influence the money supply/M_S curve/amount of currency in circulation.
To increase money supply, central banks sell govt securities. (Expansionary)
To decrease money supply, central banks buy govt securities. (Contractionary)
WHats the relationship between inflation targetting and Output gap (Y*-Y)?
Persistent output gaps create pressure for the rate of inflation to change. So the bank of canada has to design its policy to keep real GDP (Y) close to potential output (Y*).
Can we consider inflation targets as automatic stabilizers?
No they’re not as automatic as the fiscal stabilizers implemented by the government (taxation system and tax brackets).
What are the lags in monetary policy?
Monetary policy operates with a time lag that is long and variable. That is because of two reasons.
1 - Changes in expenditure take time.
2 - Multiplier process takes time.
