1. Define Bank Run
2. Define Bank panic
3. How is bank panic prevented?
1. Bank run A situation in which many depositors simultaneously decide to withdraw money from a bank.
2. Bank panic A situation in which many banks experience runs at the same time.
3. A central bank, like the Bank of Canada, can help stop a bank panic by acting as a lender of last resort. In acting as a lender of last resort, a central bank makes loans to banks that cannot borrow funds elsewhere.
Bank runs not a problem today due to the Canada Deposit Insurance Corporation (CDIC). In the U.S., Federal Deposit Insurance Corporation (FDIC).
1. When was the Bank of Canada created, when did it become a crown corporation?
2. Who manages the day to day affairs?
3. Who makes the big decisions on monetary policy?
4. Who is the senior official at the Bank of Canada, how long is the term in office and who appoints this position?
1. It was created after a Royal Commission in 1933 and came into being in 1934. In 1938, it became a Crown corporation belonging to the federal government.
2. Managed by a board of directors, composed of the governor, the senior deputy governor, and 12 directors.
Deputy Minister of Finance is an ex officio non-voting member of the Board as well.
The Board of Directors provides general oversight of the management and administration of the Bank with respect to strategic planning, financial and accounting matters, risk management, human resources, and other internal policies.
3. The Governing Council is the policy-making body of the Bank. It consists of the Governor, Senior Deputy Governor and four Deputy Governors. It is responsible for monetary policy, decisions aimed at promoting a sound and stable financial system, and the strategic direction of the Bank.
4. Dr. Stephen S. Poloz was appointed Governor of the Bank of Canada effective June 2013, for a term of seven years. As Governor, he is Chairman of the Board of Directors of the Bank.
All members of the board of directors are appointed by the minister of Finance, with 7-year terms for the governor and senior deputy governor, and 12 independent directors appointed to 3-year renewable terms.
What are the 4 primary functions of the Bank of canada?
1. Issue currency
2. Act as banker to the commercial banks (a bank’s bank; the lender of last resort)
3. Act as banker to the Canadian government
4. Control the money supply
* The money supply is the quantity of money available in the economy.
* Decisions by policymakers concerning the money supply constitute monetary policy
Describe the 3 main tools of monetary control used by a central bank?
1. Open-Market Operations (OMOs)
: the purchase and sale of government bonds
- 2. Changes in Reserve Requirement : Affect how much money banks can create by making loans
- * Not in Canada.
3. Changing the Overnight rate
: interest rate on very short-term loans between commercial banks
1. What are Open-Market Operations (OMO's)?
2. What are the two ways OMO's are used to affect monetary control?
1. the purchase and sale of government bonds
- 2a. To increase money supply, The Bank of Canada buys govt bonds, paying with new dollars.
- …which are deposited in banks, increasing reserves
- …which banks use to make loans, causing the money supply to expand.
b. To reduce money supply, The Bank of Canada sells govt bonds, taking dollars out of circulation, and the process works in reverse.
1. What is the difference between the bank rate and the overnight interest rate?
2. How does an increase in the overnight rate affect the money supply?
3. How does a decrease in the overnight rate affect the money supply?
1. The bank rate is the rate of interest central banks charge commercial banks for loans
The overnight interest rate is the rate of interest on very short-term loans between commercial banks
(always be about one quarter of a percentbelow the bank rate.)
*** The Bank of Canada can alter the money supply by changing the bank rate, which in turn causes an equal change in the overnight rate.
2. An increase in the overnight rateà discourages banks from borrowing reserves from the Bank of Canada. Therefore reduces the money supply
3. A decrease in the overnight rate increases the money supply
How can the US use Reserve Requirements (RR) to increase or decrease the money supply and how does the process work?
Reserve Requirements (RR). Affect how much money banks can create by making loans, so...
To increase money supply, Fed reduces RR.
Banks make more loans from each dollar of reserves, which increases money multiplier and money supply.
To reduce money supply, Fed raises RR, and the process works in reverse.
*** Fed rarely uses reserve requirements to control money supply: Frequent changes would disrupt banking.
1. Define monetary policy?
2. What are the BoC's 4 main monetary policy goals?
1. Monetary policy The actions the Bank of Canada takes to manage the money supply and interest rates to pursue macroeconomic policy goals.
2. The Bank of Canada has four main monetary policy goals that are intended to promote a well-functioning economy:
a. Price stability
b. High employment
c. Stability of financial markets and institutions
d. Economic growth
1. What are the three ways a central bank can manage price stability?
2. What are the two negative aspects of unemployment that the BoC wants to avoid?
3. Why does the BoC want to ensure the stability of financial markets?
4. How does the BoC ensure the stability of financial markets?
1a. Inflation targeting - Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation (e.g. 1 ~ 3 %)
b. Symmetric inflation targeting - The central bank is equally concerned about inflation rising above its target as it is about inflation falling below its target.
c. Flexible inflation targeting - The central bank does not rely on mechanical rules to achieve its inflation target, but tries to meet the inflation target over some time horizon (typically a two-year horizon).
2. a. Unemployed workers and underused factories and office buildings reduce GDP below its potential level.
b. Unemployment causes financial distress and decreases the self-esteem of workers who lack jobs. The goal of high employment extends beyond the Bank of Canada to other branches of the federal government..
3. So that an efficient flow of funds from savers to borrowers will occur.
4. While the Bank of Canada doesn’t regulate financial institutions, it does play a key role in providing liquidity to banks by acting as a “lender of last resort” the Bank of Canada reduces the risk of a financial institution— that is otherwise healthy—failing because it cannot access short-term funds.
1. Why do policymakers aim to encourage stable economic growth?
2. What is the main objective of the BoC's monetary policy?
1. Because it allows households and firms to plan accurately and encourages the long-run investment that is needed to sustain growth.
2. To keep the inflation rate between 1 and 3 percent.
1. What are monetary policy targets, and what are the two types the BoC uses?
2. Why does the money demand curve slope downwards?
3. What happens to the money demand curve when there is a decrease in the interest rate?
1.Monetary policy targets
— variables that it can directly influence and which, in turn, affect the inflation rate.
The two main monetary policy targets are the money supply
and the interest rate
The Bank of Canada typically uses the overnight interest rate as its policy target.
2. The money demand curve slopes downward because lower interest rates cause households and firms to switch from financial assets such as Treasury bills to money.
3. A decrease in the interest rate causes an increase in the quantity of money demanded. (a rightward movement along the demand curve).
1. What causes a shift in the money demand curve?
2. Visualize how you would draw this
3. How does equalibrium occur if the BoC increases the money supply?
4. Visualize what happens in the money market when the BoC increases the money supply, and when it decreases the money supply.
1. A decrease in real GDP or a decrease in the price level will cause the money demand curve to shift to the left,
whereas an increase in real GDP or the price level will cause the money demand curve to shift to the right.
3. Just as with other markets, equilibrium in the money market occurs where the money demand curve crosses the money supply curve.
When the Bank of Canada increases the money supply, the short-term interest rate must fall until it reaches a level at which households and firms are willing to hold the additional money.
- 4. When BoC increases the money supply
- When the BoC decreases the money supply
With the exception of government purchases, changes in interest rates affect the following components?
3. Net exports
1. Consumption. Lower interest rates lower the cost of durable goods and reduce the return to saving, leading households to save less and spend more.
Higher interest rates raise the cost of consumer durables and increase the return to saving, leading households to save more and spend less.
2. Investment. Higher interest rates make it more expensive for firms and households to borrow, thereby decreasing investment.
Lower interest rates increase the demand for stocks and make it less expensive for firms and households to borrow, thereby increasing investment.
3. Net exports - If interest rates in Canada rise relative to interest rates in other countries, investing in Canadian financial assets will become more desirable, causing foreign investors to increase their demand for dollars, which will increase the value of the dollar.
As the value of the dollar increases, net exports will fall. If interest rates in Canada decline relative to interest rates in other countries, the value of the dollar will fall, and net exports will rise.
1. What does the BoC do to reach its goal of high employment?
2. What does this do to the AD curve? Visualize
3. What does the BoC do to reach its goal of price stability?
4. What does this do to the AD curve?
1. To reach its goal of high employment, the Bank of Canada needs to carry out an expansionary monetary policy by increasing the money supply and decreasing interest rates.
- 2. Lower interest rates cause an increase in consumption, investment, and net exports, which shifts the aggregate demand curve to the right, from AD 1 to AD 2 .
3. To reach its goal of price stability, the Bank of Canada needs to carry out a contractionary monetary policy by decreasing the money supply and increasing interest rates.
- 4. Higher interest rates cause a decrease in consumption, investment, and net exports, which shifts the aggregate demand curve from AD 1 to AD 2 .
1. What are the 5 steps to an expansionary monetary policy?
2. What are the 5 steps to a contracionary monetary policy?
1. Expansionary Monetary Policy
a. The BoC's governing council orders an expansionary policy
b. The money supply increases and interest rates fall
c. I, C and NX will increase
d. The AD curve shifts to the right
e. Real GDP and the price level rise
2. Contractionary Monetary Policy
a. The BoC's governing council orders a contractionary policy
b. The money supply decreases and interest rates rise
c. I, C and NX decrease
d. The AD curve shifts to the left
e. Real GDP and the price level fall
Should you buy a house during a recession?
The Bank of Canada often takes actions to lower interest rates during a recession, so you may want to take advantage of that by buying a house at such time.
But, recessions are also times of rising unemployment, and you would not want to make a commitment to borrow a lot of money for 15 or more years if you were in significant danger of losing your job.
We can conclude, then, that if your job seems secure, buying a house during a recession may be a good idea.