In response to an inflationary gap, the Bank of Canada
A)waits until the price level falls before acting.
B)lowers the overnight loans rate by selling securities.
C)raises the overnight loans rate by selling securities.
D)lowers the overnight loans rate by buying securities.
E)raises the overnight loans rate by buying securities.

Question

Quizplus · Accepted Answer

To counteract an inflationary gap (a situation where actual GDP is above potential GDP), the Bank of Canada would typically raise the overnight loans rate by selling securities. This would reduce the money supply and increase the cost of borrowing, which would decrease consumption and investment spending, ultimately reducing aggregate demand and reducing inflationary pressures. Waiting for the price level to fall before acting is not an effective strategy as it may lead to a significant increase in inflation in the meantime. Lowering the overnight loans rate by buying securities would increase the money supply and stimulate spending, exacerbating inflationary pressures. Therefore, raising the overnight loans rate by selling securities is the best option.

In Response to an Inflationary Gap, the Bank of Canada