Chapter 9 Flashcards
Monetary policy, inflation targeting, Central banks use of policy, the Taylor rule
What type of policy is most often used for short run tuning?
monetary policy
What is the governing council of the bank made up of?
- 1 governor
- 5 deputy governors
- 12 members of the board of directors
What key interest rate the bank of Canada set?
the overnight rate
What do lower interest rate encourage? (think investment and consumption)
Greater investment spending and spending on consumption goods
What is monetary policies effect on supply and demand?
Monetary policy works on AD, but has little effect on AS
What four effects do higher interest rates have on AD?
- Interest rate effect
- Wealth effect
- Exchange rate effect
- Inflation expectation effect
What is the interest rate effect?
Higher interest rates cause cost of borrowing to increase, decreasing consumption and investment
What is the wealth effect?
As assets prices decrease with higher interest rates, lower wealth reduces spending
What is the exchange rate effect?
As currency appreciates, net exports fall
What is the inflation expectations effect?
As interest rates rise, lowered prices are expected, deferring spending as people wait for lower prices
What are the two goals of the central banks when they choose short run policies?
- Keep inflation low, stable, and predictable
How often does the Bank of Canada set its target for the overnight rate?
8 fixed dates each year, approximately five to eight weeks apart
What two benefits does having fixed adjustment dates for the overnight rate create?
- Markets can better prepare for changes
- Provides greater transparency on actions of the bank
What is the bank of Canada’s operating band for the target overnight rate?
It varies up and down by about 0.25 percentage, the top is the bank rate, the bottom is the deposit rate
What is the inflation target and how is it measured?
The inflation target is often 2% and is measured by CPI
What are monetary policy rules based on?
The notion that systematic policy is preferable to purely discretionary approach
What is the constant money supply growth rule?
Increase the stock of money circulating in an economy at a rate equal to the economy’s natural rate of nominal income growth
What is the Taylor Rule?
Recommends that a central bank raise short term interest rates when inflation of employment levels are high, or vice versa
Steps policy makers use to choose what to do:
- Determine where output and price level should be
- Determine how much they need to shift AD or AS to hit those targets
- Determine how large a policy change is required to move AD or AS the necessary distance
How is monetary policy carried out?
By adjusting short term interest rates
