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ECN204 Notes AFTER Midterm (cont with Ch13)

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Ryerson University
ECN 204
Amy Peng

Chapter 13 J Monetary Policy (Run by Bank of Canada) Goal: - To keep inflation low, stable & predictable - To moderate business cycle & help economy achieve full employment & sustained growth - By altering money supply to influence interest rates - Inflation target range of 1-3% annually KE š]À}Ll}L[Z,}LšŒÇ9}o] Ç Tools of Monetary Policy: - Open-market operations ** - Government Deposit Shifting - Bank Rate ** Open-Market Operations - Bank of Canada BUYS bonds - From the chartered banks ; N Chartered bank gives up bonds N Ll}L‰ÇZ ZŒšŒLlÇ]L ŒZ]L2 ZŒšŒLl[ZŒZŒÀZ ƒ Bank of Canada: Assets : (securities), Liabilities : (Reserves of Chartered Banks) ƒ Chartered Banks: Assets ; (securities), : (reserves) - From the public ; N Public gives up bonds for cheque N Cheque is deposited in chartered bank N ZŒšŒLl[ZŒZŒÀZ]L ŒZ Deposit = Excess reserves * multiplier - When Bank of Canada BUYS bonds (like loans) N ZŒšŒLl[ZŒZŒÀZincrease N Banks increase lending N Money supply increases - When Bank of Canada SELLS bonds N ZŒšŒLl[ZŒZŒÀZdecrease N Banks decrease lending N Money supply decreases Bank Rate & Overnight Lending Rate - Bank rate J interest rate Bank of Canada charges on loans to chartered banks - /ZZššµ‰‰ŒL}Ll}L[Zoperating band (higher) for the overnight lending rate - Bank has publicized target for overnight lending rate - Prime interest rate J how much interest WE pay when go to bank Relative Importance J Buying & selling securities in open market is by far MOST important, can happen anytime/day, very effective, signal for overnight change Targeting Overnight Lending Rate J low quantity of reserves = high overnight lending rate, more reserves = low overnight lending rate Expansionary Monetary Policy Suppose economy faces recession & unemployment Goal: lower interest rate 9 increase money supply by buying securities Banks will: - Buy securities, Switch government deposits to chartered banks, Reduce bank rate Contracionary Monetary Policy Suppose economy faces rising inflation Goal: higher interest rate 9 decrease money supply by selling securities Banks will: - Sell securities, lower reserves, increase bank rate Taylor Rule (empirical) - If real GDP rises by 1% above potential GDP, Bank should raise overnight rate by 1.5% - If inflation rise by 1% above its target of 2%, Bank should rise overnight lending rate by 1.5% - When real GDP = potential GDP, & inflation = target, overnight rate should remain about 4%, implying real interest rate of 2% Monetary Policy Rules - Taylor Rule i i 0b(Y Y ) p ; SHORT RUN N nominal interest rate i o real rate, when at POTENTIAL GDP N Y J actual GDP N Yp J potential GDP N b in Canada is 1.5; is SLOPE - When output temporarily exceeds potential output, central bank raises interest rates. At levels of output below potential output, it lowers interest rate
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