Econ 248 Assignment 2

Topics: Monetary policy, Inflation, Central bank Pages: 7 (1981 words) Published: January 24, 2012
ECON 248
Assignment 2
The bank rate is the interest rate at which the Bank of Canada stands ready to lend reserves to chartered banks. The banker's deposit rate is the interest rate that the Bank of Canada pays banks on their deposits at the Bank of Canada. Changes to these rates by the Bank of Canada typically spread to other interest rates and therefore will influence the amount of lending done by the banks. An open market operation is the purchase or sale of government securities, which are government of Canada Treasury bills and bonds, in the open market by the Bank of Canada. These transactions done by the Bank of Canada change the reserves of the banks, which have an immediately impact on the amount of overnight borrowing. This enables the Bank of Canada to hit its overnight rate target. Government deposit shifting is the practice of shifting government deposits between the government's account at the Bank of Canada and its accounts at the various chartered banks. These shifts of deposits affects the banks' reserves, and therefore their ability to make overnight loans. Since this tool is typically used on a small scale to smooth daily fluctuations in the amount of overnight loans, its impact on the implementation of monetary policy is small. The required reserve ratio is the portion of depositors' balances banks must have on hand as cash, as determined by the central bank. The monetary policy of a required reserve ratio is no longer in use by the Bank of Canada. The Bank of Canada's policy tools work by changing the quantity of money in the economy, by changing the monetary base. By raising the bank rate, the Bank of Canada can make it more costly for the banks to borrow reserves. By raising the interest rate it pays the banks on their own deposits at the Bank of Canada, it can induce the banks to want to hold larger reserves. By selling securities in the open market, the Bank of Canada can decrease the monetary base. The Bank of Canada can also decrease bank reserves and the monetary base by switching some government of Canada deposits from a chartered bank to itself. These actions decrease the quantity of money, other things remaining the same.

L = (1 - 0.35) X (1 - 0.07)
L = 0.6
Quantity of money created = $50,000,000 X 1/(1 - 0.6)
Quantity of money created = $50,000,000 X 2.5
Quantity of money created = $125,000,000

a) The multiplier is the amount by which a change in any component of autonomous expenditure is magnified or multiplied to determine the change that it generates in equilibrium expenditure and real GDP. Investment expenditures increase aggregate expenditure and real GDP. The increase in real GDP increases disposable income, which increases consumption expenditure. The increased consumption expenditure adds even more to aggregate expenditure. Real GDP and disposable income increase further, and so does consumption expenditure. The initial increase in investment brings an even bigger increase in aggregate expenditure because it induces an increase in consumption expenditure. The multiplier determines the magnitude of the increase in aggregate expenditure that results from an increase in investment or another component of autonomous expenditure. The greater the marginal propensity to consume, the larger is the multiplier.

b) The marginal propensity to import and the marginal tax rate together with the marginal propensity to consume determine the multiplier. Their combined influence determines the slope of the aggregate expenditure curve. Since Multiplier = 1 / (1 - Slope of AE curve) and the marginal tax rate determines the extent to which income tax payments change when real GDP changes, the size of the multiplier will decrease depending on the extent to which the marginal tax rate reduces the slope of the AE curve.

c) The slope of the AE curve equals 0.75
Multiplier = change in real GDP/change in investment = 1/(1-MPC) Multiplier = 1/(1-0.75) = 1/0.25 = 4...
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