chapter 28 Flashcards
what are the two approaches for implementing its monetary policy
- Target the money supply
- Target the interest rate
But for a given MD curve, both cannot be targeted independently
The Bank of Canada chooses to conduct monetary policy by targeting the interest rate (rather than the money supply) because :
(three reasons)
- The Bank of Canada is able to control a particular interest rate.
- Uncertainty about the slope and position of the MD curve does not prevent the Bank of Canada from establishing its desired interest rate.
- The Bank of Canada can easily communicate its interest-rate policy to the public
def. overnight interest rate
the interest rate at which major financial institutions borrow and lend one-day (or “overnight”) funds among themselves
describe the reasoning/mechanics of the overnight interest rate
• Banks that need cash because they have run short of reserves can
borrow in the overnight market from other banks that have excess reserves.
• The Bank of Canada sets a target level for that rate.
• The Bank of Canada exercises considerable influence over the overnight interest rate.
when the bank announces its target for the overnight rate, it also announces ______
- rate that charges for loans (bank rate):
2. rate that pays for deposits
rate that charges for loans (bank rate)
the interest rate the Bank of Canada charges commercial banks for loans—0.25 percentage points above the target rate. The Bank promises to lend at this bank rate any amount that commercial banks want to borrow
rate that pays for deposits:
the Bank offers to borrow (accept deposits) in unlimited amounts from commercial banks and pay them an interest rate 0.25 percentage points below the target.
The actual overnight interest rate stays within the ______________ range centred around the target rate
0.5-percentagepoint
The Bank can more or less control the overnight interest rate.
It does this by:
- Setting a target for the overnight interest rate
- Establishing the bank rate 0.25% above this target
- Establishing a borrowing rate 0.25% below target
=> keep actual overnight rate within 0.5% band
how does the bank of canada change the amount of currency in circulation?
through its open-market operations
Banks can sell some of their government securities to the Bank of Canada in exchange for cash (or electronic reserves) and then use this cash to extend new loans.
The purchase or sale of government securities on the open market by the central bank is an open-market operation
what happens as the Bank changes its target for the overnight rate?
- other interest rates change
- bank lending changes
- banks’ demand for currency changes
=> the Bank responds by supplying currency or buying currency from
commercial banks
=>the need for open-market operations
The amount of currency in circulation (and also the money supply) is __________
It is not directly controlled by the Bank of Canada, but instead is
determined by ____________
endogenous
the economic decisions of households, firms, and commercial banks
The Bank of Canada is ________ in its decisions regarding the money
supply.
It conducts its __________ to accommodate the
changing demand for currency coming from the commercial bank
passive
conducts its open-market operations
if banks need more cash what happens on open market?
open-market purchase
if banks have excess cash, what happens on open market?
open-market sale
An expansionary monetary policy occurs when the Bank of Canada
_______ its target for the overnight interest rate
reduces
what happens when the target for the overnight interest rate is reduced
eventually increases MS (or its growth rate)
A contractionary monetary policy occurs when the Bank of Canada
________ its target for the overnight interest rate.
increases
what happens when the target for the overnight interest rate is increased?
eventually decreases MS (or its growth rate)
what about inflation have central banks come to realize?
- High inflation is costly for individuals and damaging for economies.
=> High and uncertain inflation leads to arbitrary income redistributions and also undermines the efficiency of the price system. - Inflation is the one variable on which monetary policy can have a systematic and sustained influence.
what does keeping inflation to its formal 2-percent target require?
Keeping inflation close to its formal 2-percent target, requires the
Bank of Canada to monitor the output gap and the associated
pressures that may be pushing inflation above or below the target.
Persistent output gaps generally create pressure for the rate of inflation to change.
So the Bank of Canada designs its policy to keep real GDP close to potential output
in the short run, when an output gap opens, what two choices does the Bank have?
- allow the adjustment process to operate
* intervene with monetary policy
describe inflation targeting to stabilize output
• in response to a positive output shock, the Bank tightens policy
• in response to a negative output shock, the Bank loosens policy
=> policy tends to keep output close to Y*
**this is not automatic stabilization, the Bank must actively change policy
what two factors is inflation targeting complicated by?
- volatile food and energy prices
2. the exchange rate and monetary policy
describe how Volatile Food and Energy Prices complicates inflation targeting
• prices of many goods included in CPI are determined in world markets
• these may change suddenly for reasons unrelated to Canadian
output gaps
==> the Bank also monitors core inflation (excludes food, energy and the effects of indirect taxes).
describe how the exchange rate and monetary policy complicate inflation targeting
• the Bank must identify the cause of any exchange rate change before determining the appropriate policy response
• consider an appreciation of the Canadian dollar caused by an increase in demand for exports
=> Bank rises its target for overnight interest rate
• or an appreciation of the Canadian dollar caused by an increase in demand for Canadian bonds
=> Bank reduces its target for overnight interest rate
describe the timelines for the overnight interest rate
- Almost immediate effects on the exchange rate and interest rates.
- Between 9 and 12 months for the full effect on output.
- Between 18 and 24 months for the full effect on inflation.
what two main reasons make it so that monetary policy operates with a time lag that is long and variable?
- changes in expenditure take time
* the multiplier process takes time
The fact that monetary-policy actions taken today will not affect
output and inflation until one to two years in the future means that
the Bank of Canada must design its policy for __________ rather than what has already been observed.
what is expected to occur in the future
the long time lags in the effectiveness of monetary policy _______ the difficulty of stabilizing the economy
monetary policy may have a _________ effect
increase
destabilizing
