The Benefits and Drawbacks of Monetary Policy by liaoqinmei

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									Monetary Policy


Expansionary
Contractionary
Tools
Benefits/Limitations
Monetary Policy
 Monetary Policy involves
   • The Bank of Canada changing interest rates
   • The Bank of Canada altering the money supply
   • Or a combination of the above to stabilize the
     economy
                              Easy money policy

 Monetary policy can be “Expansionary” or
 “Contractionary”
                 Tight money policy
Expansionary Monetary Policy
 Expansionary monetary policy
  • is a policy of increasing the money supply and
    lowering interest rates which shifts AD
    rightward by a magnified amount due to an
    initial increase in investment and the
    consumption of durable goods
  • is used to eradicate a recessionary gap
 Expansionary Monetary Policy

                                 AS
Price
Level                                Capacity Output


        P2                           Real Output before
                                     Easy Money Policy
        P1
                               AD2
                                     Real Output after Easy
                         AD1         Money Polciy
                                     Recessionary Gap
                    Q1   Q2          closes
             Real GDP
Contractionary Monetary Policy
 Contractionary monetary policy:
  • is a policy of decreasing the money supply and
    raising interest rates which shif ts AD leftward
    by a magnified amount due to an initial
    decrease in investment and the consumption
    of durable goods
  • is used to eradicate an inflationary gap
 Contractionary Monetary Policy

                                    AS
Price                                     Capacity Output
Level
                                    Inflationary Gap closes
        P1                              Real Output before
        P2                              Tight Money Policy
                                  AD1
                                  AD2
                                          Real Output after
                        Q2   Q1           Tight Money Policy
             Real GDP
Tools of Monetary Policy
 Open Market Operations
 Government Deposits
 The Bank Rate
 Changes in Reserve Requirements
Open Market Operations
 Open market operations are a tool the Bank
  of Canada uses to conduct monetary policy
  • Buying/selling Bonds and T-Bills
     – Bank of Canada buys bonds from Canadian
       Corporations and the result is an increase in the
       money supply
     – Bank of Canada sells bonds to Canadian
       Corporations and the result is a decrease in the
       money supply because the $ is out of circulation.
Government Deposits
 Moving government deposits is another
 tool the Bank of Canada uses to conduct
 monetary policy
  • The Bank of Canada can increase the money
    supply by transferring federal government
    deposits to chartered banks
  • The Bank of Canada can decrease the money
    supply by moving the money from the
    chartered banks to its own.
Changes in the Bank Rate
 Changing the bank rate is a tool the Bank of
  Canada uses to signify its monetary policy
  intentions
  • An increase in the bank rate tells the chartered
    banks that the B of C wants a decrease in loans
    and an increase in interest rates to create a
    decrease in the money supply
  • A decrease in the bank rate tells the chartered
    banks the opposite.
Changes in Reserve Requirements

 As the reserve ratio increases, the Money
  Supply decreases
 As the reserve ratio decreases, the money
  supply increases
 The Benefits and Drawbacks of
       Monetary Policy
 Monetary policy has two main benefits
  • it is separated from day- to- day politics
  • decisions regarding monetary policy can be
    made quickly
 Monetary policy has two main drawbacks
  • it is less effective as an expansionary tool than
    as a contractionary tool
  • it cannot be focused on particular regions

								
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