Monetary Policy

The Bank of Canada is in charge of all money supply.◦ Regulates the amount of money in the system.

Manage of Money Supply

3 Main tasks: ◦ Acts as the government’s banker by clearing

federal government cheques◦ Bank holds some of the government’s bank

deposits and decides where the other deposits should be held

◦ Handles the financing of the federal government’s debt by issuing bonds.

Bank of Canada

2 Categories◦ Canada Savings Bonds◦ Treasury Bills

Government Bonds

Canada Savings Bonds: Federal government bonds that have a set value throughout their term.

Canada Savings Bonds

Treasury Bills: Short-term federal government bonds that provide no interest, but are sold at a discount.

Treasury Bills

Bank of Canada is also in charge of the stability of chartered banks.◦ This is called Monetary Policy

Stability of Financial Markets

Two different kinds:◦ Expansionary Monetary Policy◦ Contractionary Monetary Policy

Monetary Policy

A policy of increasing money supply and reducing interest rates to stimulate the economy.◦ If real out put falls a recessionary gap is created

and expansionary monetary policy is used.

Expansionary Monetary Policy

When in action: When nominal interest falls businesses respond by increasing their investment spending and households purchase more durable goods, raising consumption.◦ If consumption totalled $9 billion and value of

economy’s spending multiplier is 1.67 then total change in AD is $15 billion.

How it Works

A policy of decreasing the money supply and increasing interest rates to dampen economy.◦ Happens during an economy boom. Done to

disable investments and causes a reduction in spending.

◦ Same example as before but a decrease in $9 billion will result in a decrease of $15 billion.

Contractionary Monetary Policy

3 different tools to conduct policies:◦ Open Market Operations◦ Government Deposits◦ The bank rate.

Tools

Is the buying and selling of bonds by the Bank of Canada.◦ Selling bonds reduces cash reserves and

decreases money supply.◦ Buying of bonds increases money supply.

Open Market Operations

Moving federal government deposits from Bank of Canada to chartered banks, the Bank of Canada conducts expansionarry policy. And Vice Versa.

Government Deposits

Interest paid by members of Chartered Banks when they receive Bank of Canada advances.

Overnight Rate: the interest rate on overnight loans between chartered banks and other financial institutions.

The Bank Rate

Bank buys bonds or moves government deposits to Chartered banks then the Bank increases in value which reduces overnight borrowing.◦ Vice-Versa.

How it Works

2 main beneftis:◦ Separation from politics◦ Speed

Benefits of Monetary Policy

Unlike fiscal policy, because it is controlled by an appointed member and is secretive then policy is focused on economic goals rather than political.

Separation from politics

Monetary policy decisions can be made very quickly compared to fiscal policy.

Speed

Two major drawbacks:◦ Relative weakness as expansionary tool◦ Broad impact

Drawbacks

Using expansionary policy cannot guarantee it will translate into more bank loans and an expansion of money supply.

Expansionary Tool

Monetary affects every region instead of only being focused on one.

Broad Impact

Both monetary and fiscal policy used to control these issues.

Demand-Pull Inflation: inflation that occurs as increased aggregate demand pulls up prices.

Inflation & Unemployment

Philips Curve: a curve expressing the assumed fixed and predictable inverse relationship between unemployment and inflation.

According to Keynesian perspective if an economy with an inflation rate of 2 percent and an unemployment rate of 8 percent experiences demand-pull inflation, the inflation rate will rise as the same time unemployment decreases.

The Philips Curve

An increase in aggregate demand creates shortages in labour market, which puts upward pressures on wages, thereby boosting inflation. Decrease increases unemployment.

Used by governments to determine how policies will effect economy.

Philips Curve