FIVE FUNCTIONS OF THE BANK OF CANADA: OBJECTIVES

1) Controller of the money supply

If the money supply increases too rapidly, the AD curve shifts up and to the right, resulting in price level increases- INFLATION RESULT.

2) Banker to the commercial banks

All Canadian chartered banks have an account at the Bank of Canada where they keep a fraction of their deposits as desired cash reserves.

3) Fiscal agent and financial adviser to the government

4) Manager of the country’s monetary policy

Core CPI- refers to an adjustied version of total CPI ecluding the most volatile components including seasonal produce like fruit and vegetables, gasoline, oil, natural gas, mortgage interst.

Core inflation- a measure of inflation using the core CPI

5) Supporter of the financial system

Fiduciary monetary system- monetary system based on trust of confidence.

Brach banking system- a banking system based on relatively few banks with many branches,

Bank Act- federal legislation that governs the operations of chartered banks.

Interest spread- the difference between the interest that banks charge for loans and the interest rate they pay their depositors.

THE ASSETS OF CHARTERED BANK: notes and deposits with the BOCANADA, foreign currency deposits, cheques, loans, and mortgages.

THE LIABILITIES OF CHARTERED BANK: deposits, advances from the bank of canada, acceptances, guarantees, letters of credit and shareholders' equity.

Fractional reserve banking- a banking system in which banks keep only a fractiona of their deposits in cash reserves.

Target reserve ratio- the fraction of demand deposits that chartered banks hold as cash reserves.

Desired reserves- the minimum amount of reserves that banks desire to hold.

Primary reserves- bank reserves held in cash.

Secondary reserves- liquid assets, such as currency, day-to-day loans, treasury bills, and call and short loans, held as reserves.

Initial deposit of primary deposit- a deposit that a deposit-taking institution sells for cash.

Excess reserves- cash reserves held in excess of the desired cash reserves.

Derivative deposit or secondary deposit- a deposit that is created by a bank when it extends a loan.

Deposit expansion multiplier or money multiplier- the number by which an initial bank deposit is multiplied to arrive at the resulting total deposits. MM= 1/rr.

MM(money multiplier)

Rr( reserve ratio)

Caisses popularities and credit unions obtain most of their funds from customers’ deposits.

Caisses popularities and credit unions use their funds mainly for mortgage lending and cash loans.

Term deposits constitute the main sources of funds for trust and mortgage loan companies.

Most of the funds of trust and mortgage loan companies are used for mortgage lending.

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Tree reasons for holding money : (transactions purpose, precautionary purposes, speculative purposes)

Transactions demand for money- to desire to hold money for transaction purposes.

the transactions demand for money varies directly with the level of income.

Precautionary demand for money- the desire to hold money for unexpected contingencies( broken furnace, a blown muffler, a really big sale at a major department store)

THE precautionary DEMAND FOR MONEY VARIES DIRECTLY WITH THE LEVEL OF INCOME

Speculative demand for money – the desire to hold money in anticipation of movements in the prices of financial assets.

If interest rates are high(bond prices are low) and people expect them to fall(bonds prices to rise) they will buy bonds now, hoping to sell them for future profit.

THE SPECULATIVE DEMAND FOR MONEY IS INVERSELY RELATED TO THE RATE OF INTEREST.

THE ASSET DEMAND FOR MONEY IS INVERSELY RELATED TO THE INTEREST RATE

Liquidity preference- the desire to hold money rather than less liquid interest-earning assets.

Liquidity preference curve- the curve showing the inverse relationship between the quantity of money and the rate of interest.

OTHER THINGS BEING EQUAL, AN INCREASE IN INCOME CAUSES THE DEMAND CURVE FOR MONEY TO SHIFT TO THE RIGHT, A DECREASE IN INCOME CAUSES THE CURVE TO SHIFT TO THE LEFT.

Money supply- the total quantity of money supplied at various rate of interest.

OTHER THINGS BEING EQUAL, AN INCREASE IN THE DEMAND FRO MONEY WILL RESULT IN AN INCREASE IN THE REATE OF INTEREST.

OTHER THINGS BEING EQUAL, A DECREASE IN THE DEMAND FOR MONEY WILL RESULT IN A DECREASE IN THE REATE OF INTEREST.

OTHER THINGS BEING EQUAL,, AN INCREASE IN THE MONEY SUPPLY WILL RESULT IN A FALL IN THE RATE OF INTEREST.

OTHER THINGS BEING EQUAL, A REDUCTION IN THE SUPPLY OF MONEY WILL RESLT IN AN INCREASE IN THE RATE OF INTEREST.

Monetary policy- refers to the activities of the central bank designed to bring about changes in the money supply, the availability of credit, and the level of the interest rates in order to influence general economic activities.

CHANGING IN THE MONEY SUPPLY AND INTEREST RATES DO NOT CONSTITUTE MONETARY POLICY UNLESS THEY HAVE BEEN INITIATED BY THE BANK OF CANADA.

OBJECTIVES OF MONETARY POLICY:

1) full employment

2) price stability

3) maximum growth of real output

4) equilibrium balance of payments

THE SPECIFIC TOOLS FOR IMPLEMENTING MONETARY POLICY:

1) Open market operation

-the buying and selling of securities (bonds) by the central bank. Affects not only on money supply but also interest rates. More security purchased- interest rates will fall.

2) Central bank advances and the bank rate

Bank rate- the rate of interest that the central banks charges on loans and advances to members of the Canadian Payments Association. Bank rates rises, lending institutions raise their lending rates. Bank rates fall, they lower their lending rates and also make credit more easily available.

3) Switching government deposits and swap transactions

Redeposit or deposit switching- the act of transferring government funds from the central bank to the commercial banks. ( INCREASE BANK RESERVES AND MONEY SUPPLY)

Drawdown- a transfer of government funds from the commercial banks to the central banks. (REDUCE MONEY SUPPLY, LOSE RESERVES)

4) Purchase and resale agreement

5) Moral suasion

Any persuasive tactic used by the central bank to secure the cooperation of the commercial banks. (amplify expansionary monetary policy)

AN EXPANSIONARY MONETARY POLICY MAY BE EFFECTIVE AGAINS UNEMPLOYMENT, WHILE A CONTRACTIONARY MONETARY POLICY MAY BE EFFECTIVE AGAINST INFLATION.

Key policy rate- also the key interest rate or the target for the overnight rate, which is the interest rate at which major financial institutions borrow and lend one day funds among themselves.

Overnight rate- the target interest rate of key policy rate set by the Bank of Canada for borrowing and lending among major financial institutions.

Transmission mechanism- the process by which changes on the banks’s target interest rate of key policy reate affect the economy.

Liquidity trap- a situation in which the rate of interest is so low that people prefer to hold large amounts of money over other forms of liquid assets.

THE STEEPER THE LIQUIDUTY PREFERENCE CURVE, OTHER THINGS BEING EQUAL, THE MORE EFFECTIVE MONETARY POLICY WILL BE.

THE FLATTER THE MARGINAL EFFICIENCY OF INVESTMENT CURVE, OTHER THINGS BEING EQUAL, THE MORE EFFECTIVE MONETARY POLICY WILL BE.

Date: 2015-01-29; view: 1428