Roles Of The Bank Of Canada

Roles of the Bank of Canada November-24-08 8:22 AM

1. Regulate Economic Activity: - The governor of the Bank of Canada (Mark Coolly) and the minister of finance (Jim Flaherty) set the monetary policy of Canada, The Bank of Canada can use monetary policy to help stimulate the economy during a recession or to try and slow the economy during a period of boom.

Interest Rates High interest rates are better known as tight credit or tight monetary policy. Low interest rates are better known as loose credit or easy monetary policy. During period of easy monetary policy Canadians tend to start spending more. During periods of tight monetary policy Canadians tend to save more. Money Supply The Bank of Canada can also increase of decrease the money supply available in Canada to Canadians to try and affect their spending habits.

The Canadian Economy with Tight Monetary Policy AS AD0 Income Price AD1

Equilibrium 2 Y0 P0 Y1 P1 Full Employment, Full Output Equilibrium 1 Q1 E1

Q0 E0

OUTPUT EMPLOYMENT

Economic model : how will a tight monetary policy effect the economy. To start we must show some kind of connection between money supply and Aggregate Demand. At this point the economy is in equilibrium where the : Out level is Q0, Employment E0, Income Level Y0, Price Level P0 Now lets assume there is a decrease in money supply. How will the affect the graph? M ↓ then C ↓

Therefore As C ↓ AD ↓ to AD1 because AD = C + I + G + X + M This will cause the curve to shift to the left Now there will be a new equilibrium where AD 1 crossing the AS where the point in the economy is in equilibrium where the output level decreases to Q1, employment decreases to E1, Income Level decreases to Y1 and Price level decreases to P1.

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decreases to Y1 and Price level decreases to P1. M ↓ C ↓ AD ↓ Q ↓ EMPLOYMENT ↓ Y ↓ P ↓

The Canadian Economy with an Easy Monetary Policy

AS AD1

Income Price AD0

Equilibrium 2 Y1 P1 Y0 P0 Full Employment, Full Output Equilibrium 1 Q0 E0

Q1 E1

OUTPUT EMPLOYMENT

Economic Model: How will a change in interest rates effect the Economy. At that point the economy is in equilibrium where the output level is Q0, employment level E0, income Y0, price level P0.

Now lets assume there is a decrease in interest rates how will the effect the graph? As R ↓ S ↓ C ↑ AND THEREFORE AD ↑ TO AD1 BECAUSE AD = C + I + G+ X + M

This will cause the curve to shift to the right. Now there will be an new equilibrium where AD1 crossing the AS at that point the economy is in equilibrium where the: • • • •

Output level increases from q0 to q1 Employment increases from E0 to E1 Income level increases from Y0 to Y1 Price level increase P0 to P1

In conclusion As R ↓ S ↓ C ↑ AD ↑ Q ↑ Employment ↑ Y ↑ P ↑

2. Fight Inflation: The B of C is set up to keep an eye on inflation. The B of C is truly set up as a watch dog to make sure inflation rates do not go up that much. Currently Canada has a policy to maintain inflation below 2-3% per year. In the late 80's and early 90s B of C wanted inflation to be 0. Again B of C can use interest rates or money supply to try and maintain control of inflation. To control inflation they will use tight money policy by increasing interest rate or decreasing money supply. See graph one. 3. Regulation Foreign Exchange Rates : Canada has a floating exchange rate. This means the value of the Canadian currency is decided on the world market. It is determined by the supply of the Canadian dollars and the demand for Canadian dollars. However, at times the B of C feels that it is in the best

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dollars and the demand for Canadian dollars. However, at times the B of C feels that it is in the best interest of Canadians to regulate this activity. If the Canadian dollar falls too much this might create a panic in Canadians, so B of C steps in to prevent huge drops. Also B of C also realizes that if the Canadian dollar increases too much in value this will hurt Canadian Export market so they don't allow huge gains either. For this reason Canada does not have a free float. It has a dirty float. Example:

Dirty Float the Canadian Exchange with the Bank of Canada Intervention

S0 S1

Prices of one Canadian Dollar in terms of US E0

E1

D0

Q0

Q1

As S0 = D0 The exchange is E0 at this exchange the Bank of Canada feels the exchange is too high and will hurt the Canadian export sector, therefore they get involved and try to increase the supply of Canadian dollars which will bring the exchange rate down to E1 which is more acceptable exchange rate. 4. Regulates the Banking System: the B of C is also known as the banker's bank. The B of C is the central bank in Canada, and it holds some deposits from the Chartered banks in Canada (RBC, CIBC, BMO, TD, HSBC). The B of C also sets the laws and rules that regulate the Chartered Banks, Trust companies, Mortgage companies, and credit unions. Some of the laws that are created deal with cash reserves if the banks, lending policies of bank, service charge policies, who can become a chartered bank and etc. 5. Government's Bank : The B of C is also known as the Government of Canada's Bank. The government deposits its money with the B of C. The bank of Canada issues government bonds to be sold. It looks after the Canadian Mint, printing of Canadian money. It also covers the paying of government expenses and the collection of government revenues.

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