15.7 PROBLEMS

Question 15.14

Go to the schedule of key interest rate announcements page of the Bank of Canada’s website (www.bankofcanada.ca/monetary-policy-introduction/key-interest-rate/schedule/) to find the list of the BOC’s eight fixed interest rate announcement dates for the current year. Now, to find the most recent press release, click on “Publications and Research” and then select “Press Releases.”

  1. What is the BOC’s current target for the overnight interest rate?

  2. Is the current target overnight interest rate different from the one on the previous fixed announcement date? If it is, by how much does it differ?

  3. Does the statement comment on current macroeconomic conditions in the Canada? How does it describe the Canadian economy?

Question 15.15

How will the following events affect the demand for money? In each case, specify whether there is a shift of the demand curve or a movement along the demand curve and its direction.

  1. There is a fall in the interest rate from 12% to 10%.

  2. Cold weather arrives and with it, the beginning of the holiday shopping season.

  3. McDonald’s and other fast-food restaurants begin to accept credit cards.

  4. The BOC engages in an open-market purchase of Canadian treasury bills.

Question 15.16

  1. Go to www.bankofcanada.ca/rates/interest-rates/t-bill-yields/. Find the part of this page that deals with average yields for recent six-month Government of Canada treasury bill auctions. What is the interest rate for the most recently issued six-month T-bills?

  2. Go to the website of your favourite bank. What is the interest rate for six-month GICs?

  3. Why are the rates for six-month GICs higher than for six-month federal treasury bills?

Question 15.17

Go to www.bankofcanada.ca/rates/interest-rates/canadian-bonds/. Use the most recent data on the list of benchmark bond yields listed there to answer these questions.

  1. What are the interest rates on two-year and ten-year Government of Canada bonds?

  2. How do the interest rates on the two-year and ten-year bonds relate to each other? Why is the interest rate on the ten-year bond higher (or lower) than the interest rate on the two-year bond?

Question 15.18

An economy is facing the recessionary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy? How will the interest rate, investment spending, consumer spending, real GDP, and the aggregate price level change as monetary policy closes the recessionary gap?

Question 15.19

An economy is facing the inflationary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy? How will the interest rate, investment spending, consumer spending, real GDP, and the aggregate price level change as monetary policy closes the inflationary gap?

Question 15.20

In the economy of Eastlandia, the money market is initially in equilibrium when the economy begins to slide into a recession.

  1. Using the accompanying diagram, explain what will happen to the interest rate if the central bank of Eastlandia keeps the money supply constant at —M1.

  2. If the central bank is instead committed to maintaining an interest rate target of i1, then as the economy slides into recession, how should the central bank react? Using your diagram from part (a), demonstrate the central bank’s reaction.

Question 15.21

Suppose that the money market in Westlandia is initially in equilibrium and the central bank decides to decrease the money supply.

  1. Using a diagram like the one in Problem 7, explain what will happen to the interest rate in the short run.

  2. What will happen to the interest rate in the long run?

Question 15.22

An economy is in long-run macroeconomic equilibrium with an unemployment rate of 5% when the government passes a law requiring the central bank to use monetary policy to lower the unemployment rate to 3% and keep it there. How could the central bank achieve this goal in the short run? What would happen in the long run? Illustrate with a diagram.

Question 15.23

According to the European Central Bank website, the treaty establishing the European Community “makes clear that ensuring price stability is the most important contribution that monetary policy can make to achieve a favourable economic environment and a high level of employment.” If price stability is the only goal of monetary policy, explain how monetary policy would be conducted during recessions. Analyze both the case of a recession that is the result of a demand shock and the case of a recession that is the result of a supply shock.

Question 15.24

The effectiveness of monetary policy depends on how easy it is for changes in the money supply to change interest rates. By changing interest rates, monetary policy affects investment spending and the aggregate demand curve. The economies of Albernia and Brittania have very different money demand curves, as shown in the accompanying diagram. In which economy will changes in the money supply be a more effective policy tool? Why?

Question 15.25

During the Great Depression, businesspeople in Canada were very pessimistic about the future of economic growth and reluctant to increase investment spending even when interest rates fell. How did this limit the potential for monetary policy to help alleviate the Depression?

Question 15.26

Because of the economic slowdown associated with the 2008–2009 recession, the Governing Council of the Bank of Canada, between December 4, 2007 and April 21, 2009, lowered its target for the overnight interest rate in a series of steps from a high of 4.5% to a rate of 0.25%. The idea was to provide a boost to the economy by increasing aggregate demand.

  1. Use the liquidity preference model to explain how the BOC Governing Council lowers the interest rate in the short run. Draw a typical graph that illustrates the mechanism. Label the vertical axis “Interest rate” and the horizontal axis “Quantity of money.” Your graph should show two interest rates, i1 and i2.

  2. Explain why the reduction in the interest rate causes aggregate demand to increase in the short run.

  3. Suppose that in 2016 the economy is at potential output but that this is somehow overlooked by the BOC, which continues its monetary expansion. Demonstrate the effect of the policy measure on the AD curve. Use the LRAS curve to show that the effect of this policy measure on the AD curve, other things equal, causes the aggregate price level to rise in the long run. Label the vertical axis “Aggregate price level” and the horizontal axis “Real GDP.”