Chapter 11

Question 1

monetary policy

Answer 1

adjusting the supply of money and interest rates to achieve steady growth, full employment and price stability

Question 2

price stability

Answer 2

means inflation rate is low enough to not significantly affect peoples decisions

Question 3

inflation control targets

Answer 3

range of inflation rates set by a central bank as a monetary policy objective
- bank of canada’s target is an annual inflation rate of 1-3% as measured by the CPI
- monetary policy aims for 2%

Question 4

overnight rate

Answer 4

interest rate banks charge each other for one day loans
- bank of canadas main policy tool
- overnight rates determine all other short run interest rates not long run interest rates

Question 5

lower interest rates

Answer 5

cause increasing borrowing and spending while savings decrease
- in a recessionary gap, bank of canada lowers interest rates to increase AD and accelerate the economy

Question 6

higher interest rates

Answer 6

cause decreasing borrowing and spending while savings increase
- in an inflationary gap, bank of canada raises interest rates to decrease AD and slow down the economy

Question 7

open market operations

Answer 7

how the bank of canada changes the target interest rate by buying or selling government bonds on the bond market

Question 8

to lower interest rates and accelerate economy

Answer 8

• BOC changes money supply using open market operations to influence quantity of demand deposits (part of M1+)
• BOC BUYS BONDS, increasing bank reserves, loans, demand deposits, and money supply

Question 9

to raise interest rates and slow down the economy

Answer 9

• BOC SELLS BONDS, decreasing bank reserves, loans, demand deposits, and money supply

Question 10

prime rate

Answer 10

interest rate on loans to lowest risk borrowers

Question 11

how long does it take to change interest rates

Answer 11

up to 24 months

Question 12

open market operations and interest rates affect AD through

Answer 12

1. domestic monetary transmission mechanism
2. international transmission mechanisms

Question 13

balance sheet recession

Answer 13

falling asset prices which lead individuals and businesses to cut spending, save and pay down dept which is what happened at the start of the 2008 financial crisis
- cause transmission problems for monetary policy making it harder to steer economy toward recovery

Question 14

transmission breakdowns for monetary policy

Answer 14

where lower interest rates did NOT increase spending or AD

caused by:
- consumers: saving more, paying off debts and spending less
- businesses: pessimistic expectations decrease business investment spending even with lower interest rates
- money as a store of value: giving players a way not to spend
- banks: holding cash reserves and nOT making new loans and NOT increasing demand deposits and money supply

Question 15

quantitative easing

Answer 15

way central banks counter act transmission breakdowns
- flooding the financial system with money by buying high-risk bonds, mortgages, and assets from banks
- there is a risk of inflation from flooding financial system s with money

Question 16

who sets the inflation control target

Answer 16

gov of canada and Bank of canada
- BOC is alone responsible for monetary policy to achieve the target and has considerable independence but ultimately responsible to parliment

Question 17

since 1991

Answer 17

BOC has made sure inflation stayed within the target range

Question 18

both camps agree

Answer 18

• that markets need a central bank
• inflation control targets are an effective compormise between hands off emphasis on rules and hands on emphasis on gov discretion

Question 19

yes camp

Answer 19

• monetary policy likes targets
• no discretion for central bankers
• no opportunity for politicians to influence monetary policy

Question 20

no camp

Answer 20

• monetary policy is government discretion
• to correct transmission breakdown
• allow elected politicians to set policy