Chapter 14- Monetary Policy Herman, Joyce, Daisy, Phoebe

14.1 The Bank of Canada

Bank of Canada’s four basic functions:

1) ______2) ______3) ______4) ______

Managing the Money Supply:

In managing the money supply, the Bank is concerned with 3 goals: 1) ______2) ______3) ______

Acting as the Bankers’ Bank:

______: the interest rate CPA members are charged on advances from the Bank of Canada ______(CPA) includes the ______and ______The accounts of CPA members at the Bank of Canada, which are known as ______and are part of the CPA members’ cash reserves, are kept so that funds are available to meet the daily clearing of payments. When a CPA member finds that its account is ______, it can ______from the Bank of Canada. The Bank provides an ______, by depositing the required funds in the CPA member’s account. The interest rate charged on these loans is called the ______. Because the bank rate is ______than interest rates on other overnight loans, CPA members try to ______their loans from the Bank of Canada.

Acting as the Federal Government’s Fiscal Agent:

______: federal government bonds that have a set value throughout their term ______: short-term federal government bonds that provide no interest, but are sold at a discount In order to conduct the business of spending, taxing and so on, the federal government needs a bank to manage it transactions and financial assets. In its role as the government’s fiscal agent, the Bank of Canada engages in 3 main tasks: 1) ______2) ______3) ______Ensuring the Stability of Financial Markets:

The bank of Canada ______the operation of financial markets to ensure their stability. The Bank has particular responsibility in overseeing the activity of chartered banks. By doing so, it helps ______and ______.

14.2 Monetary Policy

 Expansionary monetary policy- a policy of ______and ______to stimulate the economy

 Lower interest rate affects aggregate demand, is that a ______makes borrowing funds ______.

 The decline in the ______interest rate will also cause the ______of interest to fall.

 3 ways businesses respond to expansionary monetary policy.

1. Increase their investment spending 2. Increase households purchase more durable goods 3. Raising consumption

 The effect is the ______as when government purchases ______.

 The formula to calculate the total change in out put is:

Total change in output = initial change __ spending (shift in AD curve) in spending multiplier

 In an expansionary monetary policy the money supply curve will shift to the ______.

 Contractionary monetary policy- a policy of ______and ______to dampen the economy.

 2 effects that contractionary monetary policy have on businesses.

1. Discourages investment spending 2. Discourages consumption spending on durable items by households.  In a contractionary monetary policy, the money supply curve will shift to the _____.

14.3 Tools of Monetary Policy

The Bank of Canada has two different tools to conduct monetary policy. 1.______2.______

Open Market Operations

 The buying and selling of bonds by the Bank of Canada in the open market called ______.  In the bond market, the Bank of Canada plays an important tool that it conducts monetary policy.  There are two transactions take place in the open bond market 1.______2. ______

Bond Sales The sale of bonds ______the cash reserves of deposit-takers, which, in turn, cuts back on lending and finally ______the supply of money. By selling bonds, the Bank of Canada engages in ______policy.

Bank of Canada Assets Liabilities Bonds -$1000 Cartier Bank’s Deposit -$1000

Cartier Bank Assets Liabilities Reserves at Bank of Canada -$1000 Bondholder A’s Deposit -$1000

Bond Purchases Buying back bonds allows the Bank of Canada to practice ______monetary policy. Cash reserves ______, resulting in ______lending, which causes the money supply to ______.

Bank of Canada Assets Liabilities Bonds +$1000 Cartier Bank’s Deposit +$1000

Cartier Bank Assets Liabilities Reserves at Bank of Canada +$1000 Bondholder A’s Deposit +$1000

The Target Overnight Rate  ______is the interest rate on overnight loans between chartered banks and other financial institutions.  The Bank makes sure that the overnight rate stays within a publicized range of _____ basis points (a basis point is one- hundredth of a percentage point, with the target overnight rate at the midpoint of this range).

 When the Band buys bonds on the open market, the accounts of CPA members at the Bank ______in value, which reduces the need for overnight borrowing and ______the overnight rate.  When the Bank engages in an open- market sale of bonds, the accounts of CPA members are reduced, ______the need for overnight borrowing as well as ______.  ______is the lower possible interest rate charged by deposit- takers on loans to their best corporate customers

Benefits of Monetary Policy

Two main benefits in monetary policy: 1.______2.______These benefits have made monetary policy the most important stabilization tool in recent years.

Separation from Day-to- Day Politics  focused on economics rather than ______ unlike fiscal policy, which is a well- publicized element of the political process, monetary policy is detached from immediate political ______.

Speed  Decisions regarding monetary policy can be made quickly

Drawbacks of Monetary Policy

Two major drawbacks in monetary policy: 1.______2.______

Weakness as an expansionary tool  it is less effective as an expansionary tool than as a concretionary tool  during recession or depression, the Bank can ______deposit- takers’ cash reserves through open market purchases of bonds  there is no guarantee that this will translate into more ______and an expansion of the ______ Increase in the money supply will not occur if deposit- takers hold on to their extra cash reserves

Board Impact  cannot be focused on particular ______ during a boom, if the Bank of Canada interest rate, then the impact is not only  in those areas with ______economies but also in areas that been relatively unaffected by the ______. Therefore, regions already continuing high ______.

14.4 Inflation and Unemployment

Part A: Demand Pull Inflation

The relationship between inflation and unemployment is usually an ______one.

The increase in price level translates into ______.

The increase in output translates into lower ______.

Demand-pull inflation: inflation that occurs as ______aggregate demand pulls up prices.

1992 = 100) = 1992 a 140deflator, (GDP Level Price AD 1

AD 0 0 750 770 Real GDP (1992 $ billions)

Part B: Phillips Curve Phillips Curve: a curve expressing the assumed fixed and predictable inverse relationship between ______and ______.

Increased aggregate demand creates shortages in labour markets, which put upward pressure on wages, thereby boosting ______. (point b to point c)

Decreased aggregate demand increases ______, which puts downward pressure on wages, thereby reducing the rate of ______. (point b to point c)

6 Inflation Rate (%) Rate Inflation

b 2 c 10 0 2 4 6 8 Unemployment Rate (%)

Stagflation: a combination of consistently ______output (and so constant or expanding unemployment) and rising inflation.

Part C: Cost-Push inflation

Cost-push inflation: inflation that occurs as ______production costs ______aggregate supply, which then pushes up prices. AS 1 AS c 0

, 15 r

o 0 t a l f

e 14 )

0 0 P 0 1 D

2 l 9 e 9 v 1 e L

e c i r P 75 77 0 0 0 Real GDP (1992 $ billions) Increased input prices cause businesses to ______output. The resulting decrease in aggregate supply means a shift in the aggregate supply curve from AS0 to AS1. The result is that the price level is pushed ____ from point d to point c. In other words, increased costs push up ______.

Money Matters

The Role of Money

 Friedman has contributed to various aspects of economics, but his most wide-ranging work is associated with the economic perspective known as ______, which emphasizes the influence of money in the economy.

 Monetarists believe that the economy is able to adjust to shocks without ______.

 Velocity of money (V) can also be defined as: the number of times, on average, that money is spent on ______and ______during a given year. \

 Formula for calculating Velocity of money is:

Velocity of money (V) = nominal GDP ___ M

 Formula to calculate Nominal GDP is:

Nominal GDP = P ___ Q  When the two formulas are combined the equation to Friedman’s theory is then created.

M ___ V = P ___ Q

The Quantity Theory of Money

 According to the quantity of theory of money, both the ______and the ______are relatively stable.  If both velocity of money and the real output are fairly stable then it assumed in the quantity theory of money, then there is a ______between ______and ______.  This can be shown by the equation of exchange, when both velocity and real output are set at constant value.  According to Friedman, ______is primarily caused by too much ______chasing the ______for purchase in an economy.

Monetarist Policies

 Friedman and other monetarists view the impact of monetary changes as being more ______and ______. In this perspective, an assumed stable velocity of money means that adjustments in the money supply translate immediately into ______and ______