theme8 Flashcards
3 types of intervention
- interest rate
- balance sheet
- foreign exchange market
Bank of Canada’s 3 interest rates
Bank rate = policy rate + 0.25 pp
- interest rate at which commercial banks can borrow from the CB
Policy rate
- target for overnight rate (effective rate at which banks lend to settle interbank transactions)
- LR thing, sets it indirectly
Deposit rate = policy rate - 0.25 pp
- rate of return on commercial deposits at the CB
all expressed at annual rates, so if 3 months: mettre exposant 1/4
Direct CB interventions (interest rate)
- Overnight rate > policy rate
open market purchases (supply money to
commercial banks in returns of assets)
increase in the supply of interbank funds
decrease in overnight rate - Overnight rate < policy rate
open market sales
decrease in the supply of interbank funds
increase overnight rate
money market
the lest risky and most liquid market
a rise in the policy rate forces other interest rates up
because policy rate (free risk rate) is the money market rate
other rates = policy rate + risk premium
money market
the lest risky and most liquid market
a rise in the policy rate forces other interest rates up
because policy rate (free risk rate) is the money market rate
other rates = policy rate + risk premium
money market
the lest risky and most liquid market
a rise in the policy rate forces other interest rates up
because policy rate (free risk rate) is the money market rate
other rates = policy rate + risk premium
Balance sheet interventions (expansion vs contraction)
Expansion: (when in recession, very low inflation, decreased demand, increased unemployment)
CB buys assets; increase money in circulation; increase AD; increase prices; increase inflation
Contraction: (economy is overheating, very high inflation)
CB sells assets; decrease money in circulation; decrease AD; decrease prices; decrease inflation
Interventions in the foreign exchange market
To weaken the currency:
CB buy foreign and sells domestic currency; increase in official reserves; currency depreciation
To strengthen the currency:
CB buys domestic and sells foreign; decrease in official reserves; currency appreciation
Neutral interest rate
the rate at which there’s no restrictive/expansionary policy
i neutral = r + inflation
Policy < Neutral : Expansion
Policy > Neutral: Restrictive
Inflationary process
Period where a lot of money is created which create money by granting loans
Money becomes bank account balances of individuals and these household bank balances enfle
Prices haven’t adjust yet, so represent more buying power
Increase demand and production
Unemployment decreases
Economy reaches the limites of its production (Y = Yp); struggle to supply demand
Upward pressure on prices; (lots of demand+production unable to meet demand)
Rising inflation
Prices rise by the same amount as the money stock - economic growth (MV = PY) & LR money neutrality
More inflation
increase workers & decrease unemployment
increase prices
increase GDP
If growth rate of Ms > growth rate of production
(Y > Yp): inflation
Floating exchange rate regime
Lets the currency fluctuate according to the supply and demand of the foreign exchange market
CB have few official reserves and little change in their official reserves
Administered exchange rate regime
Intervenes regularly
To depreciate:
buy foreign and sell domestic currency
When CB. changes its interest rates, it influences all other inerest rates in the economy
Rising policy rate:
makes risk-free liquid money market deposits more attractive, so that other markets must compete with the money market interest rate, which is the policy rate
Exemple of shock amplified on fixed exchange rate
In saudi arabia, the fall in Y causes a fall in the demand of money; fall in the interest rate
The depreciation of the SRAS is not allowed, and neither is the decrease in interest rate i = i*
CB must defends its currency to avoid change in e and i
1) buy domestic and sell foreign on foreign exchange market
2) increase i to return to i = i*
