what is monetary and fiscal policy for?
its to influence the long and short term performance of the economy
the purpose is to attempt to smooth out the businesss cycle by adopting contercyclical policies, which try to boost output during times of weak economic activity and to slow down the economy during growth periods
what does MONETARIST THEORY advocate and what are its 3 main arguments
it doesn't want government intervention to intervene in the economy.
1. they believe that the economy will gravitate toward stable economic growth, if left to its own devices.
2. increases in the money supply is a major cause of inflation
3. the best policy is to increase money supply at a stable amount that approximates the economy's long-run growth (2-3%/ year)
What is the Keynesian Theory?
and what 2 measures should they take?
and what should they do when its economy is growing to fast?
they want government intervention to stimulate the economy wheneever its operating below capacity
They should increase spending or reduced taxes to stimulate economy.
when the economy is growing to fast, the government should increase taxes and/or decrease spending
What does Supply-Side Economies advocate?
they want minimum government intervention and the maintenance of low taxes and low government spending.
* its the basis for many tax reductions in the US in 1980s
Whatis Rational Expectations Theory?
Government policy will have little effect on the economy since the economic agents will anticipate the future outcomes that will result from today's actions.
Ex. if government cuts taxes today agents will not spend the extra disposable income, but will save it since they realize the government will have to rause taxes in the future to offsett today's losses.
but if the government allows the money supply to increase in order to stimulate higher economic activity, owkrers will negotiae higher wage settlements and businesses will increase prices in order to offset the impact of inflation, therby slowly moving growth
What is Fiscal Policy? whats it main role?
the use of government taxation, spending, and deficits to affect growth.
main role is to 'smooth out' the business cycle by spending more and taxing less when the economy is weak.
when does the federal finance minister present the federal budget
and what does it include
they role out the NEW budget every fiscal year between April 1 and March 31.
it includes projections for spending, revenue, deficits and the level of debt for the upcoming year and usually atleast one additional year
What are the 4 ways Fiscal policy affect the economy
1. SPENDING and/or direct transfer to citizens
2. TAXES of various types, including direct income, sales, payroll, capital and property taxes
3. Run DEFICITS does do the job but it does continue to acknowledge the problem
- 4. AUTOMATIC STABILIZERS- automatically move counter to the business cycle
- Ex. unemployment insurance- payments incresae as unemployment rises
Income taxes rise as economic growth increases
what are the problem of having a continuous DEFICIT and its subsequent problems
- it leads to increase borrowing needs
- >will contribute to higher borrowing costs
- >will then raise costs and increase the chances of subsequent deficits
- >and the cycle will continue
What is a MONETARY POLICY and who performs it
it uses interest rates, exchange rates and the rates of money supply groth to influence demand and inflation.
It is performed by the BANK of CANADA
What members make up the BANK OF CANADA- 4 types
- Governed by Board of Directors
- Senior Deputy Governor
- and 12 Directors- one member from each province.
*Deputy Minister of Finance also sits on the Board by cannot vote.
What are the RESPONSIBILITIES of the CENTRAL BANK- 3 parts
- 1. Issuing the nation's currency
- 2. acting as banker to the central government
- 3. operating monetary policy
What is the central bank's GENERAL Duties- 4 parts
1. regularting credit and currency
2. controling and protecting the external value of the national monetary unit
3. mitigating by its influence, fluctuations in the general level of production
4. promoting the economic and financial welfare of Canada
What are the MAJOR functions of the BANK- 3 parts
1. acting for the government in the issuance and remocal of bank notes.
- 2. acting as the government's chief fiscal aent and financial advisor.
- >being the fiscal agent
- - bank advices the government on financial matters
- - administers the deposit and fund accounts
- - manages international currency reserves
- - operates for the government in foreign exchange markets
- - act as a depository for gold
- - act as the government's debt manager in issuing new debt securities and paying interest on them and retiring them
3. conducting monetary policy
In terms of MONETARY POLICY what is the Bank's responsibility.
How has monetary policy create stability and how does monetary policy become an advantage
What is the Bank's inflation rate
Bank is responsible for maintaining stability in the genereal level of prices, employment, output and trade and the external value of the Canadian dollar.
The Bank has focused on price stability, which it sees as the best way monetary policy can contribute to stability in employment, outpu and the exchange rate.
The Bank's inflation rate goal is 1-3%
How has the Bank control Inflation- MONETARY POLICY section
Bank does this trough lowering and raising interest rates. but having a open market transactions does affect money supply.
*The Bank recognizes that monetary conditions are the combined effect of interest rates and exchange rates
How does the Bank IMPLEMENT MONETARY POLICY
What is a BANK RATE
How is it set up?
- By targeting interest rates in general.
- They do this by using a bank rate- it is the rate at which the Bank of Canada is willing to lend short-term funds to the chartered banks, this is the last resort for chartered banks.
- the bank rate has been set "equal to the ceilings of its target range for overnight money rates.
What is an OVERNIGHT MONEY RATE in terms of BANK RATE
Who uses it and WHY
How is it set up
- it represents the rate at which money is lent overnight in the money market.
- governments, financial insitutions & large corporations are users and suppliers. they use it because they have excess funds or low in cash balances.
- the Bank established a 50 basis point 'operating band' (3-3.5%) for overnight money rates.
*While te Bank targets the mid-point of this bank, the upper limit is the BANK RATE
How does the Bank influence interest rates- most important is #1-
What is LVTS and whats its purpose
How does LVTS work?
- 1. CASH MANAGEMENT
- involves managing highly liquid reserved in the banking system through its 'drawdown' and 'redeposit' mechanism
- * all banks and other financial insitutions that cprear payments through the Canadian Payments Association-CPA have account with the Bank
- CPA- introduced the LARGE VALUE TRANSFER SYSTEM-LVTS.
- The system permits participating institutions to track their LVTS receipts and payments electronically on an onogoing basis.
- Participants then achieve 'zero-settlement' levels within the system through transfers to/from Gov. of Canada deposits at the Bank every day.
- At the end of the day, settlement of the positions is achieved through the overnight market- those who had deficit positions will borrow to achieve 'zero' while those with surplus positions will lend.
- Bank shifts federal funds between accounts at the BofC and demand deposits at the clearing banks, in order to give instituons unexpected positive or negative settlement balances.
- IF POSITIVE for clearing banks, they will lend out excess funds and buy securities, putting downward pressure on interest rates. * The Bank achieves this using REDEPOSITS which moves deposits from its own account to those of clearing banks.
IF clearing banks NEGATIVE- it uses DRAWDOWN-opposit of REDEPOSIT.
*Financial institutions often use this information to make judgements regarding the Bank's short-term stance
How does the Bank influence interest rates #2
How does it affect the overnight rates
#2 Open Market Operations
- the Bank can trade money market securities in the open market.
- Bank has targeted the overnight borrowing or lending rates.
- Affects the overnight rates by
- > offering to lend overnight money through a SPECIAL PURCHASE AND RESALE AGREEMENT aka REPO aka SPRA at stated rates below existing market rates in order to REDUCE RATES
>offering to borrow ivernight from financial institutions through SALE AND PURCHASE AGREEMENTS/ SRA by selling securities to the chartered banks and agreeing ti repurchase them the next day at given rates that are higher than market rates (when it wants to increase rates)
- Bank of Canada established a 50 basis point operating band for overnight money by conducting repos or specials at the ceiling rate and SRAs 50 basis points below the celing.
- *the TARGET RATE is the mid-point in this range.
- The Bank can also affect three month treasury bill rates by buying and selling T-bills from its own inventory.
- >to LOWER interest rates using this mechanism.
- - it BUYS t-bills by offering a price above the present market price, which lowers rates due to the inverse relationship between rates and prices.
- This action expands the Bank's balance sheet and effectively increases the money supply since the dealer it buys the t-bills from will likely lend out the funds it receives from the Bank.
- Since the Bank is targeting interest rates and not money supply, it will often 'neutralize' the effect on money supply through 'drawdowns'.
- When the Banks SELLS T-BILLS, it exerts pressure designed to increse interest rates.
How does the Bank influence interest rates #3
#3. MORAL SUASION
The Bank may simply ask financial insiitutions to tighten or loosen credit conditions in order to achieve its policy without action in the money market.
What are the 2 major challenges of government policy to influence economic activity which will make it successful
1. the economy is slow to react to interventions, which implies that even well designed policies may be ineffective when needed the most.
2. the economy will achieve equilibrium on its own, without intereference. rather than assisting the economy, government intervention could in fact hinder, delay or prevent this from occuring.