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Objectives
Describe the Bank of Canadas monetary policy objective, and its
THE IMPORTANCE OF POLICY : Monetary, Fiscal & Structural Policy & Central Bank Role And Policy.. continued
CHAPTER9A/10 SLIDESET10
interest rates, plus looks at the economic effects of changes in interest rates.
Explain how central bank control over nominal interest rates
that the central bank changes interest rates by shifting a vertical money supply curve. Theory includes: Demand for Money Supply of Money that is set by Bank of Canada Interest rate changes result from S & D Logic: Given demand for money .. If Central Bank changes money supply that changes short term interest rate that affect expenditures by business and consumers Bank of Canada does not affect interest rates directly but through the money supply.
transactions higher income means more transactions, hence more money held BUT Technological and financial innovation has also made money less useful to hold (e.g. credit cards, internet payments) ATMs make frequent cash replenishment easier
Costs of holding money = opportunity costs The interest that could have been earned by holding interest
(Businesses hold more than twice as much money as individuals in chequing accounts)
increase money holdings if the benefit of doing so exceeds the cost. What are the costs and what are the benefits to consider?
bearing assets Bonds and stocks pay a positive nominal return Cash and chequing accounts pay little or no interest
rates. Thousands of different assets each with their own rate of return, or interest rate. However, rates tend to rise and fall together.
demanded decreases inverse relationship and therefore the money demand curve slopes down.
GDP and/or price levels causes shifts of curve An increase in real GDP and/or an increase in the price level
and shift!
the nominal interest rate (i) Money market equilibrium determines the nominal interest rate in the economy.
The vertical money supply theory says that : if the Bank of Canada wants to increase interest rates, it must
Bank of Canada, directly set their official interest rates, and that M1 changes in response to the change in interest rates. Money demand same as last theory Money supply not a curve here .. Just interest rate level that defines money supply Logic: a change in the real interest rate => change in spending
Bank of Canada
Theory holds that central banks, including the Bank of Canada,
directly set their official interest rates, and that M1 changes in response to the change in interest rates
Contrast to the vertical money supply theory as the Bank of
M'
overnight rate target overnight rate target: rate at which it wants private banks to lend to each other overnight
These changes usually lead to moves in the prime business rate at
commercial banks and in other interest rates affecting business and household borrowing to finance purchases Prime business rate: the interest rate that commercial banks charge to their least risky business borrowers
operationsto ensure that the overnight rate stays very close to the target Large Value Transfer System (LVTS) Settlement Balance Operating band o A term used by the Bank of Canada to describe the range of possible overnight interest rates o from 0.25 percentage points below the overnight rate target to 0.25 percentage points above the target o Bank rate: upper limit of the operating band BOC announces interest changes by basis points. Basis point is one hundredth of a percentage point; term often used in describing interest rates
Downward Shift of the Operating Band for the Overnight Rate, January 2008
How does the Bank of Canada maintain its overnight rate target?
Willing to borrow at 0.25% below the target; willing to lend at
0.25% above the target Keeps the overnight rate within 0.25% of the target
Buys or sells Government of Canada bonds overnight Keeps the overnight rate very close to the target
target for the overnight rate. The overnight rate is the interest rate at which major financial institutions borrow and lend oneday (or "overnight") funds among themselves; the Bank sets a target level for that rate. This target for the overnight rate is often referred to as the Bank's key interest rate or key policy rate. Changes in the target for the overnight rate influence other interest rates, such as those for consumer loans and mortgages. They can also affect the Canadian dollar. EXCHANGE RATE. In November 2000, the Bank introduced a system of eight "fixed" dates each year on which it announces whether or not it will change the key policy rate
routinely borrow and lend money among themselves overnight, in order to cover their transactions during the day. ..settle up
The interest rate charged on those
lend them money at the rate at the top of the band, and pay interest on deposits at the bottom, there is no reason for them to trade funds at rates outside the band. The Bank can also intervene in the overnight market at the Target rate, if the market rate is moving away from the Target.
Note that in this theory: The central bank does not directly control the money supply Aim is to change interest rates, not to affect the money supply If anything, changes in nominal interest rates cause changes in the money supply Vertical money supply theory claims its the other way around
influences the level of demand for goods and services. When demand exceeds supply, prices will risethink inflation!! Influences the exchange rate of the Canadian dollar.
responds with an increase in interest rates. Save more spend less Not take loans Results in less spending and thus less GDP
If inflation is expected to fall below the 1 percent range, the
Can the Central Bank control the Nominal Interest Rate? Yes ST rate mostly by controlling the overnight rate that the Central Bank controls the nominal interest rate. Generally assumed control over short term interest rates is better than control over long term. Can the Central Bank control the Real Interest Rate? Or is it Inflation control? We know that real interest rate = nominal interest rate inflation We also know that the Bank of Canada can control the short term nominal interest rate (i) quite precisely And that inflation () changes relatively slowly after policy changes. Thus, changing nominal interest rates causes real interest rates to change by the same amount So, Yes they can control r because of lag and slow adjust of inflation
Be sure to read the Economic Naturalist 10.2 page 247 Really try to understand the concepts and terms in the article
Who is this? Why is the chairman of the U.S. Federal Reserve described by
educated??
Harvard College, B.A. in economics in 1975. PhD in economics from the Massachusetts Institute of Technology
in 1979.
He taught at the Stanford Graduate School of Business , New York
to IDEAS/RePEc.
finance.
Canada.