ECON-1007EL Chapter Notes - Chapter 29: Monetary Policy, Overnight Rate, Core Inflation

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rubygoose773

22 May 2018

School

Laurentian

Department

Economics / Science Èconomique

Course

ECON-1007EL

Professor

B. Eastman

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Chapter 29: Monetary Policy in Canada

Definitions

Overnight Interest

Rate

The interest rate that commercial banks charge one another for overnight

loans

Bank Rate

The interest rate the Bank of Canada charges commercial banks for loans

Open-Market

Operation

The purchase and sale of government securities on the open market by the

central bank

Key Points

• In principle, monetary policy can be implemented either by targeting money supply or by

targeting the interest rate. But for a given MD curve, both cannot be targeted

independently.

• By influencing the overnight interest rate, the Bank of Canada also influences the longer-

term interest rates that are more relevant for determining aggregate consumption and

investment expenditure.

• The Bank of Canada establishes a target for the overnight interest rate. Its instrument for

achieving this target is its borrowing and lending activities with commercial banks. By

raising or lowering its target rate, the Bank affects the actual overnight interest rate.

Changes in the overnight rate then lead to changes in other, longer-term, interest rates.

• Through its open-market operations, the Bank of Canada changes the amount of currency

in circulation. These operations, however, are not initiated by the Bank; it conducts them

to accommodate the changing demand for cash reserves by the commercial banks.

• High and uncertain inflation leads to arbitrary income redistributions and also hampers

the ability of the price system both to allocate resources efficiently and to produce

satisfactory rates of economic growth.

• Most economists and central bankers accept that monetary policy is the most important

determinant of a country’s long-run rate of inflation.

• Persistent output gaps generally cause pressure for the rate of inflation to change. To

keep the rate of inflation close to the 2-percent target, the Bank of Canada closely

monitors real GDP in the short run and designs its policy to keep real GDP close to

potential output.

• Inflation targets are not as “automatic” a stabilizer as the fiscal stabilizers built into the

tax-and-transfer system. However, as long as the central bank is committed to achieving

its inflation target, its policy adjustments will act to stabilize real GDP.

• Because the volatility of food and energy prices is often unrelated to the level of the

output gap in Canada, the Bank of Canada closely monitors the rate of “core” inflation

even though its formal target of 2 percent applies to the rate of CPI inflation. Changes in

core inflation are a better indicator of domestic inflationary pressures than are changes in

CPI inflation.

• Changes in the exchange rate can signal the need for changes in the stance of monetary

policy. However, the Bank needs to determine the cause of the exchange-rate change

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Document Summary

The interest rate that commercial banks charge one another for overnight loans. The interest rate the bank of canada charges commercial banks for loans. The purchase and sale of government securities on the open market by the central bank. In principle, monetary policy can be implemented either by targeting money supply or by targeting the interest rate. Its instrument for achieving this target is its borrowing and lending activities with commercial banks. By raising or lowering its target rate, the bank affects the actual overnight interest rate. Changes in the overnight rate then lead to changes in other, longer-term, interest rates: through its open-market operations, the bank of canada changes the amount of currency in circulation. To keep the rate of inflation close to the 2-percent target, the bank of canada closely monitors real gdp in the short run and designs its policy to keep real gdp close to potential output.

Related Questions

5. Fiscal policy is enacted through changes in

A. interest rates and the price level.

B. the supply of money and foreign exchange.

C. unemployment and inflation

D. taxation and government spending.

6. In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation. If the MPS is 0.25, then it could

A. increase taxes by $16 billion.

B. increase taxes by $24 billion.

C. decrease government spending by $10 billion.

D. decrease government spending by $16 billion.

7. If there is a constitutional requirement to maintain a balanced budget, then during a recession when tax revenues are shrinking, the government will have to implement

A. contractionary fiscal policy.

B. no change in fiscal policy.

C. expansionary fiscal policy.

D. countercyclical fiscal policy.

8. Most economists believe that fiscal policy is:

A. better than the monetary policy for "fine-tuning" the economy.

B. better than the monetary policy for month-to-month stabilization.

C. not as good as the monetary policy for month-to-month stabilization.

D. not very good at pushing the economy in a particular direction.

9. An increase in the legal reserve ratio

A. increases the money supply by increasing excess reserves

B. decreases the money supply by decreasing excess reserves

C. increases the money supply by decreasing excess reserves

D. decreases the money supply by increasing excess reserves

10. The discount rate is the rate of interest at which

A. Federal Reserve Banks lend to commercial banks

B. savings and loan associations lend to some builders

C. Federal Reserve Banks lend to large corporations.

D. commercial banks lend to large corporations

11. Which of the following actions by the Fed most likely increase commercial bank lending?

A. raising the reserve ratio

B. increasing the federal funds rate target

C. reducing the interest paid on excess reserves held at the Fed

D. selling bonds to commercial banks and the public

12. Assume the economy is operating at less than full employment. An expansionary monetary policy will cause interest rates to ______, which will ______ investment spending.

A. decrease; decrease

B. decrease; increase

C. increase; increase

D. increase; decrease

sapphirecrow883

Each Federal Reserve Bank is

Answer

		a corporation.
		a government owned enterprise.
		a government subsidized entity.
		a government-sponsored enterprise.

A transaction in which the Fed agrees to buy a security one day and sell it back the next day is

Answer

		an overnight securitization operation.
		a repurchase agreement.
		a legal tender.
		a rebate sale.

The Federal Reserve document that states the goals of the FOMC and the target for the federal funds rate is known as the

Answer

		Directive.
		Beige book.
		Bluebook.
		Green book.

How long is the normal term in office for a Governor of the Federal Reserve Board?

Answer

		Five years
		Seven years
		Fourteen years
		Life

The federal funds rate is the interest rate on

Answer

		loans to banks from the Fed.
		loans by banks to the Fed.
		short-term loans between banks.
		Treasury bills.

Expenditures of each Federal Reserve Bank are approved by

Answer

		the U.S. Senate.
		the President of the United States.
		the U.S. Treasury Department.
		the Federal Reserve Board of Governors.

Federal Reserve Banks pay for their central banking operations through

Answer

		government tax revenue.
		interest on the securities they own.
		fees charged to banks that use their services.
		dividends paid by local banks.

When the Fed engages in open-market operations, the transactions are conducted by

Answer

		the Open Market Desk at the Federal Reserve Bank of New York.
		the Open Market Desk at the Federal Reserve Board in Washington, D.C.
		the National Bureau of Economic Research.
		the Federal Open Market Committee.

In 2006, Chairman Greenspan left the Fed because

Answer

		President Bush wanted him to resign.
		he reached mandatory retirement age.
		his term as Governor expired.
		his term as Chairman expired.

The Federal Reserve publication that discusses forecasts for the economy is known as the

Answer

		Redbook.
		Beigebook.
		Bluebook.
		Greenbook.

The FOMC directive

Answer

		describes forecasts for the economy.
		states the target for the federal funds rate.
		discusses the regional economies around the country.
		shows the Fed's balance sheet.

The chairman of the Federal Reserve Board who reduced the inflation rate from over 10 percent to about 3 percent in the early 1980s was

Answer

		Arthur Burns.
		G. William Miller.
		Paul Volcker.
		Alan Greenspan.

Which Fed chairman ensured the independence of the Federal Reserve in the 1950s?

Answer

		William McChesney Martin
		Arthur Burns
		Paul Volcker
		G. William Miller

There are ____ Federal Reserve Banks.

Answer

		seven
		ten
		twelve
		fifteen

Purchases and sales of government securities in the secondary market are known as

Answer

		discount borrowing and lending.
		federal funds purchases and sales.
		discounting.
		open-market operations.

The monetary base can be divided into

Answer

		currency plus transactions deposits.
		vault cash plus reserves held at the Fed.
		required clearing balances plus currency.
		reserves plus currency.

The Fed does not generally change reserve requirements to affect the money supply because

Answer

		the impact is too large.
		the Fed needs the approval of Congress to do so.
		it's not legal for the Fed to do so.
		the Fed needs the approval of the President of the United States to do so.

The Fed has decided to tighten monetary policy, so it decreases the money supply through

Answer

		defensive open-market operations.
		dynamic open-market operations.
		reduced discount loans for profit.
		reduced discount loans for business needs.

A haircut is

Answer

		the extra collateral the Fed requires above the value of a discount loan.
		the extra principal a commercial bank requires the Fed to pay when making a discount loan.
		the difference between what an investor pays for a bond and what the investor sells the bond for.
		expected personal grooming for a member of the Board of Governors.

Currency held by the nonbank public plus banks' vault cash plus banks' deposits at the Fed equals

Answer

		the Fed's capital stock.
		discount loans.
		the monetary base.
		required clearing balances.

The extra collateral the Fed requires above the value of a discount loan is known as

Answer

		the term premium.
		a haircut.
		a covenant.
		secondary credit.

Currency held by the nonbank public plus banks' reserves equals

Answer

		the Fed's capital stock.
		discount loans.
		the monetary base.
		required clearing balances.

The money supply divided by the monetary base equals

Answer

		the reserve ratio.
		velocity.
		high-powered money.
		the money multiplier.

The main liability on the Federal Reserve's balance sheet is

Answer

		discount loans.
		securities.
		monetary base.
		capital.

A bank in good condition may take out a loan without the Fed questioning the purpose or nature of the loan. Such a loan is known as

Answer

		a no documentation discount loan.
		a haircut.
		a covenant.
		a primary credit discount loan.

If the Open-Market Desk at the Fed buys securities when the federal funds rate is below the primary credit discount rate, the most likely effect is that the

Answer

		federal funds rate decreases.
		primary credit discount rate decreases.
		primary credit discount rate increases.
		federal funds rate increases.

In November and December, people use more currency than usual, so the Fed increases the money supply through

Answer

		defensive open-market operations.
		dynamic open-market operations.
		discount loans for profit.
		discount loans for business needs.

Reserves held by banks at the Fed that earn implicit interest payments in the form of earnings credits for Fed services are known as

Answer

		required clearing balances.
		reserve requirements.
		excess reserves.
		non-transaction deposits.

Required clearing balances

Answer

		pay interest in the form of earnings credits.
		count as reserves and can be used to meet reserve requirements.
		pay interest equal to the federal funds rate minus one percent.
		are required to be held against transactions deposits.

1. The Federal Funds Rate is set by the Federal Reserve on the first business day of each month by faxing the rate to the member banks of each Federal Reserve District.

A. True

B. False

2. The Federal Reserve is a single Central bank located on Wall Street in New York City.

A. True

B. False

3. Which of the following is NOT true about the Federal Reserve System?

A. Terms of service of the members of the Board of Governors are longer than the number of years that a two-term President of the United States would serve.

B. The Federal Reserve System is the nation's central bank and is comprised of 12 Federal Reserve Banks that serve as bankers' banks.

C. Some of the main functions of the Federal Reserve System include the authority to control the money supply, to issue currency, to set reserve requirements, and to hold reserves.

D. While Congress controls the actions of the Federal Reserve, the President has the authority to appoint and remove private banks from the Federal Reserve System.

4. Which of the following is NOT true about restrictive monetary policy?

A. A restrictive monetary policy seeks to raise the federal funds rate.

B. A restrictive monetary policy seeks to expand the money supply.

C. A restrictive monetary policy seeks to raise the Federal Funds Rate by selling government bonds or raising the reserve requirement ratio or increasing the discount rate.

D. A restrictive monetary policy is used when the government is concerned about suddenly increasing inflation.

5. Which of the following statements is NOT true about contractionary fiscal policy?

A. Contractionary fiscal policy consists of reductions in government spending or increases in taxes.

B. Contractionary fiscal policy can include both reductions in government spending or increases in taxes.

C. Contractionary fiscal policy seeks to shift the Aggregate Demand curve to the right.

D. Contractionary fiscal policy is used when the government seeks to reduce suddenly surging inflation.

6. The Federal Reserve creates money by printing the amount of desired new money and distributing it via armored trucks and high-security railways to Federal Reserve District Banks.

A. True

B. False

7. If the Fed feared a looming recession was just around the corner, which of the following actions would it "NOT" consider?

A. The Fed would raise the discount rate.

B. In order to influence prevailing commercial interest rates to fall, the Fed would buy large amounts of government securities.

C. In order to expand the money supply (which influences prevailing commercial interest rates to fall), the Fed would either buy large volumes of government bonds, lower the reserve requirement or cut the discount rate.

D. The Fed would seek to expand the money supply because, in so doing, the federal funds rate would fall and that would stimulate commercial interest rates to fall.

8. Which of the following statements is NOT true about the ability of the Federal Reserve System to expand the money supply?

A. The Federal Reserve System uses the fractional nature of the banking system to create money in order to expand the money supply.

B. The money multiplier defines the relationship between new excess reserves throughout the banking system and the creation of money by banks in the system. It is calculated by dividing the number 1 by the Required Reserve Ratio. [1/rr].

C. If the required reserve ratio is 20%, then $80 billion in new excess reserves will create $400 billion in bank system lending throughout the entire banking system.

D. If the reserve requirement is 100%, then the banks can generate 100% in new excess reserves.

9. Which of the following is NOT true about the tools of monetary policy?

A. The Fed can alter the money supply through open market operations, changes in the reserve ratio or adjustments to the discount rate.

B. Lowering the reserve ratio would expand the money supply.

C. Raising the discount rate would restrict the money supply.

D. Adjusting the reserve requirement is the most important day-to-day method for controlling the nation's money supply.

10. If the Federal Reserve wishes to hold off a feared recession, it will sell large volumes of government bonds.

A. True

B. False

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ECON-1007EL Chapter Notes - Chapter 29: Monetary Policy, Overnight Rate, Core Inflation

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