EC140 Lecture Notes - Lecture 16: Overnight Rate, Aggregate Demand, Money Supply
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Does a drop in interest rates lead to an increase in investment (and consumption/net exports) How fast do input prices adjust, eliminating any gain from aggregate demand. 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 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.