monetary policy

The bank of Canada

Canada’s central bank since 1935

Four basic functions of the Bank of Canada

1. Manages the money supply (Monetary Policy)

2.Acts as the banker’s bank

3. Acts as bank to the Federal government

4.Helps to supervise the operations of financial markets to ensure stability.

A year after its founding, with a mandate to “promote the economic and financial welfare” and regulate its money supply, the Bank of Canada issued the first bank note series on March 11, 1935. Denominations were printed in either English or French, featuring portraits of royal family members or former prime ministers (something that is still a feature on our bank notes today), as well as themes that represented Canada. The series featured a $25 and $500 note, and raised ink, intricate patterns and small, green dots were among the security features.

The $20 note featured a portrait of Princess Elizabeth (who would become reigning monarch, Queen Elizabeth II). The notes were the biggest they've ever been, measuring 152.4 by 73.025 mm.

Tools of monetary policy

1. Setting the Bank Rate

2.Open market operations

3.Controlling the reserve ratio

4.Moral Suasion

setting the bank rate

Bank rate is interest (i) paid by chartered banks to the B of Cbanks use this to set their prime rate- prime rate =

lowest possible i charged by banks on loans to best

corporate customers

bank rate cont’d.

as prime rate varies, all other rates for all other depositors and borrowers also vary.

open market operations

The buying and selling of federal government bonds by the Bank of Canada

- bonds are sold to decreases the

money supply (tight money policy)

- bonds are bought to increase the

money supply (easy money policy)

controlling the reserve ratio

the B of C can move gov’t deposits to or from chartered banks to increase or decrease the money available for loans (and therefore the money supply).

controlling the reserve ratio

the B of C can also tell the chartered banks how much their deposits they must retain as a reserve.

i.e. if $1000 is deposited in a bank they may be required to keep $100, loan out only $900

moral suasion

only used in rare circumstances - the B of C will influence or pressure the chartered banks to follow a particular policy without actually putting specific measures in place.

types of monetary policy

EASY MONEY

used in the case of a recessionreduce interest

rates and increase the

money supply.purchase gov’t

bonds, increase lending ability of

banks.

types of monetary policy

TIGHT MONEYused in the case

of a boom/inflationincrease interest rates and decrease

the money supply.

sell gov’t bonds, decrease lending ability of banks.

benefits of monetary policy

Is more focused on economic rather than political goals

decision can be made and put into place quickly - therefore acts with much greater speed than fiscal policy.

...and that will make Mark Carney smile

drawbacks of monetary policy

no guarantees that it will work

will affect every region of the country uniformly.

other limitations

Tight $ policies work better than easy $.- i.e. low i will not encourage spending for those uncertain

about the future.-however - high i will discourage spending.

Policies may affect the value of the Canadian dollar

-high i - foreigners invest - buy C$, increase the value-low i - foreigners move investments - sell C$,

decrease the valueHigh i will affect the government deficit

- interest rates apply to the government too.

...and that will make Mark Carney sad.

Some other important

terminology

Some other important

terminology

These are all key factors the government must consider when

determining fiscal policy

These are all key factors the government must consider when

determining fiscal policy

The Paradox of Thrift(Ultimately, savings will prevent

savings.)peaking economy means greater ability to save.

increased savings = decreased demand.economy heads toward

recession.people must use up savings to survive.

MPC and MPSMarginal Propensity to Consume

What % of each added dollar of income will be spent?

Marginal Propensity to Save

What % of each added dollar of income will be saved?

The Multiplier Effect

The multiplied effect upon GDP that results from a change in people’s incomes.

Spending Addition to GDPCumulative

increase in GDP

First round $100 $100 $100

Second round (0.67 X100) = 67

67 167

Third round (0.67 X 67) = 45

45 212

Fourth round (0.67 X 45) = 30

30 242

Fifth round (0.67 X 30) = 20

20 262

Sixth round (0.67 X 20) = 13

13 275

etc.

Total all rounds 300 300With an MPC of 0.67, an initial expenditure of $100 generates a $300 addition to the GDP through the

respending process.