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Lecture

ECON 105 Chapter 29: Monetary Policy in Canada

6 Pages
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Department
Economics
Course Code
ECON 105
Professor
Tony Xiang

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Description
Chapter 29: Monetary Policy in Canada In this chapter you will learn... 1. …why the Bank of Canada chooses to directly target interest rates rather than the money supply. 2. …how changes in the Bank of Canada’s target for the overnight interest rate affect longer-term interest rates. 3. …why many central banks have adopted formal inflation targets. 4. …how the Bank of Canada’s policy of inflation targeting helps to stabilize the economy. 29.1 How the Bank of Canada Implements Monetary Policy Money Supply Versus the Interest Rate For any given money demand curve, any central bank must choose between: - targeting the money supply - targeting the interest rate Both cannot be targeted independently. The Bank of Canada chooses to implement its monetary policy by targeting interest rates (rather than the money supply) because: 1. The Bank can control an interest rate more easily than it can affect the money supply. 2. Instability of money demand. 3. Easier to communicate its policy through changes in interest rates. But which interest rate (of many) does the Bank target? The Bank of Canada and the Overnight Interest Rate The Bank can more-or-less control the overnight interest rate It does this by: 1. Setting a target for the overnight interest rate 2. Establishing the bank rate 0.25% above this target 3. Establishing a borrowing rate 0.25% below target  keep actual overnight rate within 0.5% band APPLYING ECONOMIC CONCEPTS 29-1 “Unconventional” Monetary Policy During the 2007-2008 Financial Crisis As the Bank changes its target for the overnight rate: - other interest rates change (eg. prime rate) - bank lending changes - banks’ demand for currency changes  the Bank responds by supplying currency or buying currency from commercial banks  the need for open-market operations But these transactions are done passively by the Bank of Canada:  the money supply is endogenous APPLYING ECONOMIC CONCEPTS 29-2 What Determines the Amount of Currency in Circulation? An expansionary monetary policy occurs when the Bank of Canada reduces its target for the overnight interest rate  eventually increases M (oS its growth rate) An expansionary monetary policy occurs when the Bank of Canada increases its target for the overnight interest rate  eventually decreases M (or its growth rate) S 29.2 Inflation Targeting Why Target Inflation? Over the past few decades, central banks have come to realize two things: 1. High inflation is costly for individuals and damaging for econom
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