chapter 13

Question 1

2 alternative approaches to monetary policy

Answer 1

• target the money supply
• target the rates
  Canada targets the rates

Question 2

Why does canada target the interest rate?

Answer 2

1. BOC is able to control a particular rate
2. slope and position of Md is uncertain, targeting rates isn’t influenced by this uncertainty
3. easy to communicate

Question 3

What does the bank charge and pay

Answer 3

charge 25bps above target
pays 25bps under the target

Question 4

As the bank changes target overnight rate…

Answer 4

• other interest rates change
• bank lending changes
• bank’s demand for currency changes
  Respond by either buyin or supplying currency to the banks

Question 5

Why is the money supply endogenous

Answer 5

It is not directly controlled by the Bank of Canada, but instead is
determined by the economic decisions of households, firms, and
commercial banks.
The Bank of Canada is passive in its decisions regarding the money
supply.
It conducts its open-market operations to accommodate the
changing demand for currency coming from the commercial banks.

Question 6

Why target inflation?

Answer 6

1. High inflation is costly for individuals and damaging for economies –» high and uncertain inflation leads to arbitrary income redistribution and undermines the efficiency of the price system
2. Inflation is the one variable on which monetary policy can have a sustained and systematic influence

Question 7

Two choices when there are output gaps

Answer 7

• allow the adjustment process to operate
• intervene with monetary policy

Question 8

Two factors that complicate inflation targeting

Answer 8

• volatile food and energy prices
• exchange rate and monetary policy:
  must identify the casue for exchange rate change:
• consider an appreciation of the Canadian dollar caused by
  an increase in demand for exports
  –» Bank rises its target for overnight interest rate
• or an appreciation of the Canadian dollar caused by
  an increase in demand for Canadian bonds
  –» Bank reduces its target for overnight interest rate

Question 9

lags: actions on the overnight rate have:

Answer 9

• almost immediate effects on the exchange rate and interest rates
• 9-12 months for full effect on output
• 18-24 months for effect on inflation

Question 10

2 main reasons for lags

Answer 10

• changes in expenditure take time
• the multiplier process takes time

All this means that monetary policy can have a destabilizing effect