MONETARY POLICY Flashcards
Explain how the Bank of Canada reduces the supply of reserves?
By selling bonds to banks or Financial Intermediaries
b) Explain, using a graph, what effect a decrease in the supply of reserves has on the target overnight rate?
the supply curve (vertical) is going to shift to the left thus an overnight rate goes up.
What effect does a decrease in reserves have on the overall level of prices? Explain
Increasing Interest rates : négative impact on investment and Consumption and AD which puts downward pressures on prices
Should this policy (decrease of reserves) should be adopted when the economy is in a slowdown?
NO. The policy in this case should be COUNTERCYCLICAL. The Central Bank should stimulate economic activity and that supposes a drop of interest rates which can be obtained with an increase in reserves
Explain why the independence of central banks has an impact on inflation.
Inflation is more under control when Central Banks are independent. Otherwise, governments are tempted to use the printing press to lower the real value of their debt.
Why might we be tempted to remove monetary policy from the control of governments?
Governments are not credible in their promise of a low and stable rate of inflation and are tempted to increase the growth rate of money supply.
Explain the tension between an independent central bank and a democratic society.
Central Bankers are not elected and as such might not represent the interest of a majority of people. Thus, a tension.
Why have Central Banks been criticized for waiting too long to increase their policy rates?
A number of economists had indicated that pent up demand and a high growth rate of money supply would cause much higher rates of inflation. Plus, the supply shocks contributed also. These events happened way before Central Banks started hiking their policy rates.
A supply shock
is a sudden, unexpected event that significantly impacts the supply of goods or services in an economy, causing changes in production costs and prices
T OR F : If the Bank of Canada decreases its policy rate this will have a negative impact on Canadian exports.
False. The decrease will lead to lower interest rates, and a depreciation of the Canadian dollar which will favor exports (making them cheaper).
T OR F : If you own a bond that pays 5.0 in interest, an expansionary monetary policy will yield a capital gain for you.
True. An expansionary monetary policy will lead to lower interest rates making bonds that pay higher interest rates more attractive. this will increase their price and as such there will be a capital gain.
T OR F : When the Bank of Canada reduces its policy rate, it takes months before it has an impact on interest rates.
False. The impact is almost immediate, it is the impact on the real side of the economy (consumption and investment that takes more time to fully absorbr the change of interest rates.
T OR F : A Central Bank that is credible in its policy of lowering inflation will reduce expected inflation.
True. Credibility means that inflation will go down as the policy is implemented. Agents will believe the Central Bank and this will be reflected throughout the economy (prices and wages).