ECON 102 Chapter Notes - Chapter 29: Open Market Operation, Monetary Policy, Money Supply
CHAPTER 29: MONETARY POLICY IN CANADA
29.1: How the Bank of Canada Implements Monetary Policy
Remember: Money supply is the sum of currency in circulation and total bank deposits, and
commercial banks play a key role in influencing the level of these deposits. As a result, the
Bank of Canada cannot directly set the money supply. As we will soon see, the Bank of
Canada is also unable to directly set interest rates. The BOC “targets” the money supply or
interest rate rather than “setting” them directly.
Money Supply VS. The Interest Rate
● Any central bank has two alternative approaches for implementing its monetary
policy- it can choose to target the money supply or it can choose to target the interest
rate. But not both at the same time!
Part (i) of figure 29-1 shows how the BOC could attempt to shift the Ms curve directly, by
changing the amount of currency in circulation in the economy. It could do this by buying or
selling government securities in the financial markets- transactions called OPEN-MARKET
OPERATIONS. Eg. by using currency to buy $100,000 of government bonds, the BOC would
increase the amount of cash reserves in the banking system by $100,000. The combined
effect of the new reserves and the new deposit money would be an increase in the money
supply and thus a shift of the Ms curve to the right. For a given Md curve, this increase in
money supply would lead to a reduction in the equilibrium interest rate and, through the
various parts of the transmission mechanism, to an eventual increase in aggregate demand.
The bank of canada doesn’t do this (ok then why talk about it lmao bYE) for three reasons:
1) While the BOC CAN control the amount of cash reserves in the banking system,
(through open market operations), it cannot control the process of deposit expansion
carried out by the commercial banks. And since the money supply is the sum of
currency and deposits, it follows that the Bank can influence the money supply but
cannot control it.
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2) Uncertainty regarding the slope of the Md curve. Even if the Bank had perfect control
over the money supply (WHICH IT DOESN'T), it would be unsure about the change
in the interest rate that would result from any given change in the supply of money.
3) In addition to being uncertain about the slope of the Md curve, the bank is also
unable to predict accurately the position of the Md curve at any given time (so
basically the bank of canada is useless)
Short version:
1) The BOC can’t control the process of deposit creation
2) There is uncertainty regarding the slope of the Md curve
3) There is uncertainty regarding the position of the Md curve
Targeting the interest rate directly: most common approach by central banks. As part (ii) of
29-1 shows, if the Bank can directly change the interest rate, the result will be a change in the
quantity of money demanded. In order for this new interest rate to be consistent with
monetary equilibrium, the Bank must accommodate the change in the amount of money
demanded.
Ok here’s a list of shit again but feel free to skip bc i’ll condense it in like 1 paragraph
Why does the bank of canada choose to implement its monetary policy in this manner?
Advantages:
1) The bank can’t control the money supply (lmao losers), however it is able to almost
completely control a particular interest rate (more on that later$$)
2) The Bank’s uncertainty about the slope and position of the Md curve is not a problem
when the Bank chooses instead to target the interest rate directly.
3) The Bank can more easily communicate its policy actions to the public by targeting
the interest rate than by targeting the level of reserves in the banking system.
Changes in interest rate are more meaningful to firms and households than changes
in the level of reserves or the money supply.
Condensed:
1) The bank of Canada is able to control a certain interest rate
2) Uncertainty about the slope and the position of the Md curve does not prevent the
BOC from establishing its desired interest rate
3) The BOC can easily communicate its interest-rate policy to the public.
The Bank of Canada and the Overnight Interest Rate
Overnight interest rate: the interest rate that commercial banks charge one another for
overnight loans
Term structure of interest rates: overall pattern of interest rates corresponding to
government securities of different maturities
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ECON 102 Full Course Notes
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Document Summary
29. 1: how the bank of canada implements monetary policy. Remember: money supply is the sum of currency in circulation and total bank deposits, and commercial banks play a key role in influencing the level of these deposits. Bank of canada cannot directly set the money supply. As we will soon see, the bank of. Canada is also unable to directly set interest rates. The boc targets the money supply or interest rate rather than setting them directly. Any central bank has two alternative approaches for implementing its monetary policy- it can choose to target the money supply or it can choose to target the interest rate. Part (i) of figure 29-1 shows how the boc could attempt to shift the ms curve directly, by changing the amount of currency in circulation in the economy. It could do this by buying or selling government securities in the financial markets- transactions called open-market.
