EC140 Lecture Notes - Lecture 16: Relative Price, Inflation Targeting, Redistribution Of Income And Wealth

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7 Mar 2018

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Ec 140- lecture 16: chapter 28; monetary policy in canada. Difficult to know the slope of the money demand curve. Difficult to know when the money demand curve will shift. Difficult to control the money supply- banks can change target reserve ratios. If the bank targets the money supply, the interest rate will fluctuate. If the interest rate affects behaviour, why not just target the interest rate. Targets the overnight interest rate: rate charged on loans between commercial banks. Announces a bank rate, 0. 25 percentage points above the overnight rate: offers to lend money to banks at this rate. Sets a deposit rate 0. 25 percentage points below the overnight rate: pays this rate on all deposits. Banks have an incentive to set their overnight rates close to the target. Bank of canada chooses to set policy to affect the economy. Increases investment, increases consumption, and increases net exports.

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The steps in the transmission of monetary policy are:

(i) Increase in government expenditures by the government which subsequently increases the aggregate demand.

(ii) Increase in money supply by the government that decreases the interest rate and lead to an increase in the aggregate demand.

(iii) Increase in government expenditures by the Federal Reserve leading to an increase in the aggregate demand.

(iv) Increase in the budget deficit by the government, which increases the money supply leading to an increase in the aggregate supply.

(v) A decrease in the federal funds rate by the Federal Reserve which lowers the real interest rate and subsequently increases the aggregate demand.

Which of the following can help to explain why higher inflation may lead to currency appreciations?

(a) The interest rate is not the prime target of monetary policy.

(b) Most central banks adjust their policy interest rates expressly so as to keep inflation in check.

(d) Inflation will increase the purchasing power of a currency.

(e) The world market does not adjust their currency trade to reflect inflation

According to the interest-rate-based monetary policy transmission mechanism, an increase in the money supply generates:

a. lower interest rates, which causes an increase in planned real investment spending and an increase in aggregate demand.

b. spending on consumer goods and services directly, which causes an increase in aggregate demand.

c. an increase in nominal GDP and a change in the price level, but no change in real GDP.

d. an increase in aggregate supply since the supply of money is part of aggregate supply.

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EC140 Lecture Notes - Lecture 16: Relative Price, Inflation Targeting, Redistribution Of Income And Wealth

EC140 Full Course Notes

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EC140 Lecture Notes - Lecture 16: Overnight Rate, Monetary Policy, Aggregate Demand

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