Lesson 7 - Chapter 10: Central Banking and Monetary Policy

Monetary policy indicators

-variables that provide information about the stimulus or restraint coming from the central bank's policy -real and nominal interest rates, exchange rates and rates of growth of money aggregates relative to national income can be used as indicators

3 main operating techniques of the central banks

1. reserve requirements imposed on commercial banks 2. open-market operations 3. bank rate setting -used to manage the monetary base, the money multiplier, and interest rates

effective lower bound (ELB)

A Bank's policy interest rate cannot be set below a small positive number.

What effects do changes in the central bank's policy instrument have?

change nominal and real interest rates and change aggregate demand through the transmission mechanism (which includes wealth effect, cost of financing effects, and exchange rate effects on the components of aggregate expenditure)

Forward guidance

information on the timing of future changes in the central bank's interest rate setting

exchange rate target

monetary policy maintains a fixed price for foreign currency in terms of domestic currency

Inflation rate target

monetary policy objective defined as an announced target inflation rate

For most central banks, what is the instrument of monetary policy

the Bank cannot control money supply exactly when in practice, thus for most central banks a short-term interest rate is the instrument of monetary policy

overnight rate

the interest rate large financial institutions receive or pay on loans from one day until the next -BoC uses the overnight interest rate as its policy instrument

Bank rate

the interest rate the central bank charges on its loans to commercial banks

Monetary policy instrument

the monetary variable the central bank manipulates in pursuit of its policy target. (ex. interest rate)

How can central banks implement monetary policy

through the monetary base and money supply control, or through interest rate control, but cannot do both simultaneously

Bank of Canada

-Canada's central bank -source of the monetary base -sets short-term interest rates -acts as a banker to the commercial banks and the federal government -the lender of last resort to the banks

Quantitative easing

-a large scale purchase of government securities to increase the monetary base to meet unusually high demands for liquid balances in times of financial and economic crisis

Central Bank

-an institution that conducts monetary policy using its control of monetary base and interest rates -operate to influence the behaviour of other banks and intermediaries in the financial system -banker to the government and to the commercial banks

monetary policy

-central bank action to control inflation and support economic growth through control of the money supply, interest rates, and exchange rates in order to change aggregate demand and economic performance -responsibility of the BoC

Credit easing

-the management of the central bank's assets designed to support lending in specific financial markets -increase in specific kinds of central bank asset holdings (ex. commercial paper) designed to provide liquidity and support lending in specific markets facing shortages of funds

Prime lending rate

The base for setting the interest rates charged by banks on loans and lines of credit.

Special Purchase and Resale Agreements (SPRAs)

a Bank of Canada purchase of securities one day combined with an agreed resale of the securities the next day

SRA

a Bank of Canada sale of securities one day combined with an agreed repurchase of the securities the next day

Money supply target

a central bank adjusts interest rates and the monetary base to control the nominal money supply, or the rate of growth of the nominal money supply

Moral suasion

a central bank persuades and encourages banks to follow its policy initiatives and guidance

required reserve ratio

a legal minimum ratio of cash reserves to deposits

What is the BoC inflation rate percentage policy target

an inflation rate of 1% to 3%

Taylor rule

central bank interest rate settings based on inflation and output targets

Open marker operation

central bank purchases or sales of government securities in the open financial market