Download policy designed to change the money supply, credit availability, and

LO2
Monetary Policy
– policy designed to change the money supply, credit
availability, and interest rates
– responsibility of the Bank of Canada
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LO2
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
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LO2
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
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LO2
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
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LO2
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
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LO2
Contractionary Monetary Policy
MS2
MS1
A  in MS leads
to interest rate 
r2
Interest rate (%)
r1
Q2
Q1
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Quantity of money
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LO2
Contractionary Monetary Policy
A higher interest rate
leads to a  in investment
spending
r2
Interest rate (%)
r1
I2
I1
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Quantity of investment
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LO2
Aggregate expenditures
Contractionary Monetary Policy
A ↓ in investment
leads to a ↓ in AE
AE1
AE2
Y1
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Y2
Real GDP
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LO2
Price level
Contractionary Monetary Policy
AS
The ↓ in AE shifts
AD to the left
P1
P2
AD1
AD2
YFE
Yε
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Real GDP
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The Effects of
Contractionary Monetary Policy
P
LO2
Potential GDP
AS
• contractionary
monetary policy
reduces AD1 to AD2
• the inflationary gap
(YE – YFE) is
thereby closed
AD1
AD2
YFE
YE
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The Effects of
Expansionary Monetary Policy
LO2
Potential GDP
P
AS
AD1
YE
• expansionary
monetary policy
increases AD1 to AD2
• the recessionary gap
(YFE - YE) is thereby
closed
AD2
YFE
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Criticisms of
Keynesian Monetary Policy
LO2
– 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
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