Chp30 - Monetary Policy Flashcards
1
Q
Monetary Policy Objective
A
- control the quantity of money
- control interest rates
- avoid inflation
- prevent excessive swings in RGDP growth and unemployment
2
Q
Inflation Rate Targetting
A
- the task of Central Bank to pick a certain inflation rate and achieve that rate
- Measured via the CPI
- focuses on core inflation (e.g. excludes oil, food)
- Benefits of targeting
- to make clear goals of Central Bank to traders
- provides anchor for expectations about future inflation
3
Q
Inflation Rate Targeting Controversy
A
- not everyone believes targeting is helpful
- in targeting inflation , the Central Bank could unintentionally force a recession
- could permit the value of the dollar to rise in foreign markets hurting exports
- However, it is argued that keeping inflation low makes the max contribution to achieving full employment and sustained growth
4
Q
Monetary Policy Instruments of the Bank of Canada
A
- The Monetary Base (quantity of money)
- The Exchange Rate
- The Short-Term Interest Rate (the opportunity-cost of holding money)
- The Bank can set any one of these, but not all three
- because changing one effects all the others
5
Q
Overnight Loans Rate
A
- The interest rate on overnight loans that big banks make to each other
- This is the interest rate that the BofC targets
- BofC will usually only change it by a 1/4 of a percent
- Achieves the target via: Operating Band, and Open Market Operation
6
Q
Operating Band
A
- The target overnight loans rate +-0.25 percentage points
- Created by the Bank Rate, and the Settlement Balances Rate
- Bank Rate: the interest rate the BofC charges on big banks for loans
- the target overnight rate +0.25 percentage points
- Settlement Balances Rate: amount of interest BofC pays to banks on their reserves in the BofC
- the target overnight rate -0.25 percentage points
- Overnight Rate cannot exceed Operating Band because other banks could turn a profit off BofC
7
Q
Open Market Operation
A
- determines the actual quantity of reserves in the banking system
8
Q
Controlling Overnight Rate
A
- Above target
- buy securities to increase reserves
- increases supply of overnight funds and lowers rate
- Below target
- sells securities to decrease reserves
- decreases supply of overnight funds and raises rate
9
Q
Ripple Effect of Changing Overnight Loans Rate
A
- lower Overnight Rate
- short-term interest rate & exchange rate falls
- quantity of money & supply of loanable funds increase
- long-term real interest rate falls
- Consumption Expenditure, Investment, & NX increase
- Aggregate Demand Increases
- RGDP growth and inflation rate increase
- Raise Overnight Rate (vice versa)
10
Q
Interest Rate Changes
Effect of Changing Overnight Rate
A
- change in the Overnight Rate effects: 3-Month Treasury Bill Rate and the Long-Term Bond Rate
- 3-Month Treasury Rate: moves fairly close to Overnight Rate
- The Long-Term Bond Rate: higher than other two rates due to increase risk; does not fluctuate as much as the above short-term rates
11
Q
Exchange Rate Fluctuation
Effect of Changing Overnight Rate
A
- responds to changes in the interest rate in Canada relative to the interest rates of other countries
- When overnight rate raises, CDN Dollar appreciates (and vice versa)
12
Q
Monetary and Bank Loan Fluctuation
Effect of Changing Overnight Rate
A
- rise in overnight rate decreases quantity of money and bank loans (and vice versa)
- change occurs due to: quantity of deposits and loans created by the banking system changes, and the quantity of money demanded changes
13
Q
Long-Term Real Interest Rate Fluctuations
Effect of Changing Overnight Rate
A
- Demand and Supply in the loanable funds market determine the long-term real interest rate
- fall in overnight rate increases the supply of loanable funds and lowers the equilibrium real interest rate (and vice versa)
14
Q
Expenditure Plan Fluctuations
Effect of Changing Overnight Rate
A
- overnight rate effects: Consumption Expenditure, Investment. Net Exports
- Consumption Expenditure: lower real interest rate = greater CE and lower saving (and vice versa)
- Investment: lower real interest rate = greater investment (and vice versa)
- Net Exports: lower interest rate = lower exchange rate = greater exports and less imports
15
Q
RGDP and Price Level Fluctuations
Effect of Changing Overnight Rate
A
- change in aggregate demand results in change in RGDP and price level
