Chapter 13 - Monetary Policy in Canada Flashcards
What is the Bank of Canada’s main tool for implementing monetary policy?
Targeting the overnight interest rate, not the money supply
What is the goal of inflation targeting?
To keep inflation around 2%, promoting price stability and economic predictability
Why doesn’t the Bank of Canada target the money supply?
Because money demand is unpredictable and commercial banks control deposit creation
What are the advantages of targeting interest rates over money supply?
Greater control, easier public communication, and less impact from uncertainty in money demand
What is the bank rate and deposit rate relative to the target overnight rate?
Bank rate = Target + 0.25%
Deposit rate = Target – 0.25%
What happens to other market rates when the overnight rate changes?
They adjust quickly, influencing credit markets and long-term borrowing
What does it mean that the money supply is “endogenous”?
It is determined by economic activity and commercial bank behaviour, not directly set by the BoC
What is expansionary monetary policy?
Lowering the overnight rate to stimulate investment, consumption, and aggregate demand
What is contractionary monetary policy?
Raising the overnight rate to slow down spending and reduce inflationary pressure
What is the monetary transmission mechanism?
A 4-stage process:
- BoC changes overnight rate
- Affects other interest rates and capital flows
- Changes exchange rates and investment/consumption
- Shifts AD → affects real GDP and price level
What does BoC do when Y < Y* (recessionary gap)?
Uses expansionary policy to lower interest rates and raise GDP
What does BoC do when Y > Y* (inflationary gap)?
Uses contractionary policy to raise interest rates and cool the economy
What’s the “divine coincidence” in inflation targeting?
Stabilizing inflation also tends to stabilize real GDP
How do exchange rates complicate monetary policy?
They impact net exports and inflation, and policy responses depend on what caused the exchange rate change
What does BoC monitor to avoid misleading inflation signals?
Core inflation, which excludes volatile items like food and energy
How long are monetary policy lags for GDP and inflation?
~9–12 months for real GDP
~18–24 months for inflation
Why must monetary policy be forward-looking?
Because policy effects are delayed, and reacting to current data could destabilize the economy
What were the main lessons from the 1980s?
Tight monetary policy can reduce inflation, but focus should shift to interest rates over money supply
What did the BoC introduce in 1991?
Formal inflation targeting, aiming for 1–3% inflation
What was quantitative easing (QE) during COVID-19?
The BoC bought government bonds with newly created cash reserves to boost liquidity and lower long-term rates
What are the 5 key policy chains to know?
1.↓ overnight rate → ↓ interest → ↑ I & C → ↑ AD → ↑ GDP
- ↓ i → ↓ CAD → ↑ NX → ↑ AD → ↑ GDP
- Y < Y* → ↓ inflation → BoC ↓ i → ↑ AD → Y → Y*
- Y > Y* → ↑ inflation → BoC ↑ i → ↓ AD → Y → Y*
- Policy action → i changes immediately → spending lags → GDP shifts (9–12 mo) → inflation shifts (18–24 mo)
What’s the monetarist view of the Great Depression?
Falling money supply caused the collapse; the Fed failed to act
What’s the Keynesian view of the Great Depression?
Falling autonomous spending caused the collapse; MS decline was the result
