Question 1

Suppose the Canadian economy had an inflationary gap. To decrease the level of aggregate desired investment, the Bank of Canada could

Accepted Answer

To decrease the level of aggregate desired investment, the Bank of Canada would need to reduce overall spending and subsequently the demand for goods and services. The most effective way for the Bank of Canada to decrease spending without disrupting the economy is to raise its target for the overnight interest rate. This would make borrowing more costly and decrease the overall demand for goods and services, ultimately decreasing the inflationary gap.

Question 2

The Bank of Canada conducts its open- market operations directly in response to

Accepted Answer

The Bank of Canada conducts its open-market operations in response to the changing demand for currency from the commercial banks. Open-market operations involve the buying and selling of government securities, which affects the amount of reserves held by commercial banks, and therefore their demand for currency from the central bank. The Bank of Canada adjusts its open-market operations in response to changes in demand to keep the overnight interest rate at its target level.

Question 3

If there were a large and persistent recessionary gap, an appropriate monetary policy could include

Accepted Answer

Reducing the Bank's target for the overnight interest rate would make borrowing cheaper for individuals and businesses, encouraging them to spend and invest more, which would stimulate aggregate demand and help close the recessionary gap. The other options listed would likely have the opposite effect and could exacerbate the recessionary gap.

Question 4

In 1980, the annual inflation rate in Canada was

Accepted Answer

In 1980, Canada experienced high inflation, with the annual inflation rate exceeding 12 percent due to various economic factors, including oil price shocks and monetary policy challenges.

Question 5

Given its existing policy regime of "inflation targeting", the Bank of Canada would likely react to a large negative AD shock by

Accepted Answer

Inflation targeting focuses on maintaining price stability, and in response to a negative AD shock, the Bank of Canada would likely lower its target for the overnight interest rate to promote economic growth and increase aggregate demand. This would lead to lower borrowing costs and increased spending, thus helping to mitigate the effects of the shock.

Question 6

One reason that the Bank of Canada does not try to influence the money supply directly is that

Accepted Answer

The Bank of Canada does not try to influence the money supply directly because the slope of the money demand curve is not precisely known, making the effect on the interest rate of a change in money supply uncertain.

Question 7

Given its existing policy regime of "inflation targeting", the Bank of Canada would likely react to a large positive aggregate demand shock by

Accepted Answer

With "inflation targeting" as its existing policy regime, the Bank of Canada aims to keep inflation within a target range by adjusting the overnight interest rate. Therefore, in response to a large positive aggregate demand shock, the Bank of Canada would likely increase its target for the overnight interest rate to keep inflation in check and prevent it from exceeding the target range. This would decrease aggregate demand and help prevent excessive inflation.

Question 8

Suppose the Bank of Canada raises its target for the overnight interest rate and longer- term rates in the market rise as a result. Households' and firms' demand for loans from the commercial banks would . In order to accommodate this change, the commercial banks require .

Accepted Answer

The increase in interest rates makes borrowing more expensive, reducing the demand for loans. To accommodate this change, banks need fewer cash reserves to meet the lower demand for loans.

Question 9

In practise, the Bank of Canada uses monetary policy to reduce undesirable fluctuations in real GDP by

Accepted Answer

The Bank of Canada influences real GDP by adjusting the target for the overnight interest rate, which indirectly affects market interest rates, consumption, and investment.

Question 10

If an economist supports targeting inflation as opposed to monetary fine- tuning, this economist probably believes that time lags in the implementation of monetary policy are

Accepted Answer

An economist who supports targeting inflation believes that monetary fine-tuning is not an effective method of controlling inflation due to the long and unpredictable nature of time lags in the implementation of monetary policy. Therefore, choice B is the best answer.

Question 11

The Bank of Canada implements an expansionary monetary policy by

Accepted Answer

The Bank of Canada implements an expansionary monetary policy by reducing its target for the overnight interest rate. This makes it cheaper for banks to borrow money, which in turn makes it cheaper for businesses and consumers to borrow money. This leads to an increase in spending and economic growth.

Question 12

Suppose output is at its potential level and then there is a sudden increase in food and energy prices. This increase

Accepted Answer

The Bank of Canada targets "core" inflation, which excludes volatile items such as food and energy prices. Therefore, sudden increases in food and energy prices would not have a significant impact on the Bank of Canada's inflation targeting framework.

Question 13

Most economists now accept the proposition that

Accepted Answer

A sustained monetary contraction is generally required to reduce the long-run rate of inflation, as it decreases the money supply and curbs inflationary pressures.

Question 14

In 2007 and 2008, Canada was affected by the global financial crisis that had begun with the U.S. housing collapse. By 2009, the Canadian economy had entered a recession, largely due to a reduction in investment and a . The policy objective for the Bank of Canada and the government at this time was to .

Accepted Answer

The Canadian economy entered a recession due to a fall in net exports, and the policy objective was to shift the aggregate demand (AD) curve to the right to close the recessionary output gap.

Question 15

Long time lags in the effectiveness of monetary policy

Accepted Answer

Long time lags in monetary policy mean that the effects of policy changes take time to manifest in the economy, making it difficult for the Bank of Canada to fine-tune the economy effectively.

Question 16

Which of the following events would justify the Bank of Canada implementing an expansionary monetary policy, while maintaining its commitment to its inflation target?

Accepted Answer

A stock market crash following a sudden shock to the economy, such as a terrorist attack, can lead to a decrease in aggregate demand and lower economic growth. To counteract this, the Bank of Canada may implement an expansionary monetary policy, such as reducing interest rates, to encourage borrowing and spending and stimulate economic activity while maintaining its commitment to its inflation target. The other options listed either suggest inflationary pressures or a strengthening of the Canadian dollar, which would warrant a contractionary monetary policy.

Question 17

Any central bank, including the Bank of Canada, can implement its monetary policy by directly influencing either or , but not both.

Accepted Answer

The Bank of Canada can directly influence either the money supply or the interest rate, but not both at the same time. When it increases the money supply, it lowers interest rates, and when it reduces the money supply, it raises interest rates. This is because increasing the money supply increases the amount of funds available for lending, which in turn leads to a decrease in the price of borrowing (a lower interest rate). Conversely, reducing the money supply lowers the amount of funds available for lending, which leads to an increase in the price of borrowing (a higher interest rate).

Question 18

The Bank of Canada implements a contractionary monetary policy by

Accepted Answer

The Bank of Canada can implement a contractionary monetary policy by raising its target for the overnight interest rate. When the overnight interest rate increases, banks must pay a higher interest rate to borrow money from the central bank, which increases the cost of borrowing and lending for consumers and businesses. This leads to a decrease in spending and investment, which ultimately reduces inflation and slows down economic growth.

Question 19

High and uncertain inflation is damaging to the economy because

Accepted Answer

High and uncertain inflation can result in unexpected reallocations of real income, as borrowers and lenders, workers and firms, and individuals receiving fixed nominal incomes are all affected. Additionally, the price system becomes less effective as a signaling mechanism for changes in relative scarcity through changes in relative prices, further damaging the economy.

Question 20

The long- run target currently used by the Bank of Canada is to set

Accepted Answer

The Bank of Canada's current long-run target is set for the inflation rate. The target range is 1-3% with a midpoint of 2%.

Quiz 29: Monetary Policy in Canada