Chapter 5 - Economic Policy (Done)

Question 1

What is the difference between fiscal policy and monetary policy?

Answer 1

• Fiscal Policy: Refers to the government’s use of taxation and spending to influence the economy. It is managed by the government and aims to achieve economic objectives such as controlling inflation, reducing unemployment, and fostering economic growth.
• Monetary Policy: Involves the management of the money supply and interest rates by a country’s central bank (like the Bank of Canada) to control inflation, manage employment levels, and maintain financial stability.

Question 2

Can you describe the difference between a budget surplus and a budget deficit?

Answer 2

• Budget Surplus: Occurs when a government’s revenue (mainly from taxes) exceeds its expenditures over a given period, allowing it to save money or pay off existing debt.
• Budget Deficit: Happens when a government’s expenditures surpass its revenue, leading to borrowing and an increase in national debt to cover the shortfall.

Question 3

How would you define the national debt?

Answer 3

National Debt: The total amount of money that a government owes to creditors, which can include domestic and foreign individuals, businesses, and other governments. It accumulates over time when a government runs budget deficits.

Question 4

How does the government affect the economy through spending?

Answer 4

Government spending influences the economy by increasing demand for goods and services. This can stimulate economic growth, create jobs, and fund infrastructure projects. However, excessive spending can lead to higher national debt and inflation.

Question 5

How does the government affect the economy through taxation?

Answer 5

Through taxation, the government can influence consumer behavior and redistribute wealth. Higher taxes reduce disposable income, potentially slowing down economic activity, while lower taxes can increase spending and investment. Tax policies can also address social issues by providing incentives or disincentives for certain behaviors.

Question 6

Can you outline the Bank of Canada’s four main areas of responsibility?

Answer 6

• Monetary Policy: Managing the money supply and interest rates to control inflation and stabilize the currency.
• Currency Issuance: Producing and distributing Canadian banknotes and ensuring their security.
• Financial System Stability: Promoting a stable and efficient financial system, including oversight of financial institutions and payment systems.
• Funds Management: Managing government funds, including foreign exchange reserves and public debt operations.

Question 7

What are the key monetary policy tools employed by the Bank of Canada?

Answer 7

• Open Market Operations: Buying and selling government securities to influence the money supply and interest rates.
• Policy Interest Rate (Overnight Rate): The rate at which banks borrow and lend overnight funds. Adjusting this rate influences other interest rates in the economy.
• Reserve Requirements: Regulations on the minimum amount of reserves that banks must hold, affecting their lending capacity.
• Forward Guidance: Communicating future monetary policy intentions to influence economic expectations and behaviors.

Question 8

Can you describe the difference between overnight reverse repos and overnight repos?

Answer 8

• Overnight Repo (Repurchase Agreement): A short-term loan where one party sells securities to another with an agreement to repurchase them at a higher price the next day. It temporarily increases the money supply.
• Overnight Reverse Repo: The opposite transaction where the central bank sells securities with an agreement to buy them back the next day, temporarily decreasing the money supply.

Question 9

What effects would drawdowns and redeposit have on inflation?

Answer 9

• Drawdowns: When the government withdraws funds from its account at the central bank to pay for expenses, it injects money into the economy, potentially increasing demand and inflation.
• Redeposit: When the government deposits funds into its account at the central bank, it reduces the money supply, potentially decreasing demand and inflation.

Question 10

What is the target overnight rate of interest?

Answer 10

The target overnight rate is the interest rate at which the Bank of Canada wants financial institutions to lend and borrow funds with each other on an overnight basis. It influences other interest rates, including those for consumer loans and mortgages, and is used to control inflation and stabilize the economy.

Question 11

If the Bank of Canada lowers the target for the overnight rate of interest from 1.75% to 1.25%, what happens to the operating bands?

Answer 11

The operating band typically spans 0.5 percentage points around the target rate. If the target rate is lowered to 1.25%, the upper limit of the operating band would be 1.5%, and the lower limit would be 1.0%. This adjustment helps guide short-term interest rates within the economy.

Question 12

Can you describe the Lynx System?

Answer 12

Lynx System: Canada’s high-value payment system, which processes large-value or time-sensitive payments between financial institutions. It ensures that these transactions are settled in real-time, enhancing the efficiency and stability of the financial system.

Question 13

Can you list and explain some of the challenges of implementing government policy?

Answer 13

• Economic Uncertainty: Unpredictable economic conditions can affect the outcomes of policies.
• Political Constraints: Political agendas and changes in leadership can alter policy priorities and implementation.
• Budget Limitations: Limited financial resources can restrict the scope and effectiveness of policies.
• Public Resistance: Policies may face opposition from the public or interest groups, complicating their implementation.
• Global Influences: International economic conditions and policies can impact domestic policy effectiveness.