Chapter 5: Economic Policy

Question 1

What is “crowding out”?

Answer 1

When government borrows significantly and reduces the capital available for business investments.

Question 2

What is fiscal policy?

Answer 2

Spending and taxation

Question 3

What is the Bank’s main role?

Answer 3

Promote the economic and financial welfare of Canada

Question 4

How can the government stimulate the economy under fiscal policy?

Answer 4

1. Increase spending

2. Lower taxation

Question 5

What are the 4 main responsibilities of the Bank of Canada?

Answer 5

1. Promote a financial system that operates efficiently
2. Design, print, and distribute Canadian bank notes
3. Manage government accounts and foreign exchange reserves and debts and advise the government on what types of bond to issue
4. Monetary policy

Question 6

What is monetary policy?

Answer 6

Government policy related to money like money supply, interest rates, exchange rates, and inflation.

Question 7

What happens when interest rates increase and decrease?

Answer 7

Increase:

• borrowing decreases
• consumption decreases
• helps to slow the economy

Decrease:

• borrowing increases
• consumption increases
• helps to spur the economy

Question 8

What happens when money supply increase and decrease?

Answer 8

Increase:

• price decrease
• interest rate falls
• helps to spur the economy

Decrease:

• prince increase
• interest rate increases
• helps to slow the economy

Question 9

3 main ways the government can influence money supply and interest rates?

Answer 9

1. Target overnight rate
2. Open market operations
3. Drawdown and redeposits

Question 10

What is overnight rate?

Answer 10

Interest rate in the overnight market which major financial institutions lend each other money in the form of one-day loans

Question 11

What is bank rate?

Answer 11

The rate that Bank of Canada charges a chartered bank for a one-day loan.

Question 12

What is basis points?

Answer 12

100 basis points in 1.00%

so 0.01 = 1 basis points

Question 13

How does Bank of Canada’s overnight rate measure in operating band?

Answer 13

The overnight rate operates within an operating band that is 50 basis points (0.50%) and is set at the upper limit.

Question 14

What is the midpoint target overnight rate?

Answer 14

Midpoint = target range

Question 15

How many predetermined dates does the Bank of Canada announce per year on target rate changes? And what does this announcement tell the marketplace?

Answer 15

8 and tells the future direction of interest rates

Question 16

What are the two primary open market operations that the government uses to influence interest rates?

Answer 16

1. Special purchase and resale agreements (SPRAs)

2. Sale and repurchase agreements (SRAs)

Question 17

What is the purpose of “special purchase and resale agreements (SPRAs)”?

Answer 17

Special purchase and resale agreements (SPRAs) is one of the two primary open market operations used to lower interest rates.

Question 18

What is the purpose of “sale and repurchase agreements (SRAs)”?

Answer 18

Sale and repurchase agreements (SRAs) is one of the two primary open market operations used to increase interest rates.

Question 19

What is a “drawdown”?

Answer 19

When Bank of Canada wants to decrease money supply it draws down on its balances at the chartered banks leaving them with less money to lend.

Drawdown = decrease money supply = higher interest rates

Question 20

What is a “redeposit”?

Answer 20

When Bank of Canada wants to increase money supply it redeposits money to its accounts at the chartered banks leaving banks with more money to lend.

Redeposit = increase money supply = lower interest rate

Question 21

The 6 challenges of government policy.

Answer 21

1. Timing lags
   Takes 18 months to determine issue, decide on action to take, implement, and see outcome
2. Political considerations
   Political business cycles can impact decisions
3. Future expectations
   Can cause policies to fail
4. Coordination across all levels of government
   Federal government policies are implemented nationally but sometimes only selected provinces may need the policy
5. High federal debt
   Can limit government spending
6. Impact of international economies
   Trading partners can impact Canada’s economy

Question 22

Advantages of monetary policy? (3)

Answer 22

1. More immediate effect (interest rate, inflation, etc)
2. Initiative can be easily reversed
3. Not as politically charged as spending and taxation

Question 23

Disadvantages of monetary policy? (3)

Answer 23

1. Difficult to target specific region with federal decisions
2. Consumers may not spend if confidence is low
3. When interest rates are low, a rate cut may not have impact

Question 24

Advantages of fiscal policy? (3)

Answer 24

1. Can target specific regions
2. Tax cuts and government spending are favoured
3. Easier for consumers to understand (impacts more directly and see day-to-day)

Question 25

Disadvantages of fiscal policy? (3)

Answer 25

1. Tax increase and spending cuts are not favoured
2. Difficult to reverse decisions once started (ie. cannot build a bridge halfway)
3. Higher government spending can result in increased debt and therefore increased costs to service the debts