Monetary Policy

– policy designed to change the money supply, credit availability, and interest rates

– responsibility of the Bank of Canada

LO2

9- 1© 2012 McGraw-Hill Ryerson Limited

Monetary Policy

Expansionary Monetary Policy– a policy that aims to increase the amount of money

in the economy and make credit cheaper and more easily available

Contractionary Monetary Policy – a policy in which the amount of money in the

economy is decreased and credit becomes harder to obtain and more expensive

LO2

9- 2© 2012 McGraw-Hill Ryerson Limited

Monetary Tools

1. Open market operations - buying and selling securities by the Bank of Canada in the open market

2. Switching government deposits - transfer deposits from a commercial bank to the Bank of Canada to decrease money supply - transfer deposits to a commercial bank to increase money supply

3. Targeting the overnight rate 4. Moral suasion

LO2

9- 3© 2012 McGraw-Hill Ryerson Limited

Keynesian Transmission Process

Keynesian monetary policy goals

1. Steady growth in real GDP

2. An exchange rate that ensures a viable balance of trade

3. Stable prices

4. Full employment

LO2

9- 4© 2012 McGraw-Hill Ryerson Limited

Keynesian Transmission Process

Transmission process

- the Keynesian view of how changes in money affect (transmit to) the real variables in the economy - the interest rate provides the link between the money market and the goods market

LO2

9- 5© 2012 McGraw-Hill Ryerson Limited

Contractionary Monetary Policy LO2

9- 6© 2012 McGraw-Hill Ryerson Limited

Contractionary Monetary Policy LO2

9- 7© 2012 McGraw-Hill Ryerson Limited

Contractionary Monetary Policy LO2

9- 8© 2012 McGraw-Hill Ryerson Limited

Contractionary Monetary Policy LO2

9- 9© 2012 McGraw-Hill Ryerson Limited

The Effects of Contractionary Monetary Policy

LO2

9- 10© 2012 McGraw-Hill Ryerson Limited

Potential GDP

ASAS

AD1

AD2

YFE YE

P

• contractionary monetary policy reduces AD1 to AD2• the inflationary gap (YE – YFE) is thereby closed

The Effects of Expansionary Monetary Policy

LO2

9- 11© 2012 McGraw-Hill Ryerson Limited

• expansionary monetary policy increases AD1 to AD2• the recessionary gap (YFE - YE) is thereby closed

Potential GDP

AS

AD1AD2

YFEYE

P

Criticisms of Keynesian Monetary Policy

– The twin goals of full employment and stable prices are incompatible

–May not be possible to achieve them together

– The best a central bank can do is achieve a delicate balance between the two, without ever attaining either goal

LO2

9- 12© 2012 McGraw-Hill Ryerson Limited