INTRODUCTION
●monetary policy: measures taken by a central monetary authority (central bank) to influence the economy by regulating interest rates and the money supply
●central bank: a single institution that controls the price and quantity of money
○acts as a last resort lender to commercial (chartered) banks
●money supply: total amount of money in circulation in an economy (quantity of money)
●interest rates: the amount charged for borrowing money (price of money)
GOALS OF MONETARY POLICY
●decrease unemployment (expansionary monetary policy)
●prevent inflation (contractionary monetary policy)
CASE STUDY: US QUANTITATIVE EASING (QE) IN 2008
●quantitative easing: large scale creation of digital money through the purchase of assets
○unconventional monetary policy first widely attempted by US Federal Reserve to stimulate the economy during the Great Recession (major businesses failed, unemployment reached 10%, markets crashed)
- the Fed “creates” money by claiming to have an amount of digital USD on its balance sheets
- floods the market with this money through the purchase of government bonds and/or corporate bonds
- banks use this money to increase lending to businesses and consumers, increasing the overall supply of money
●approximately 12 million USD have been QEd since 2008
●benefits of QE
○banks have a greater supply of money to lend, thus decreasing interest rates (price of borrowing money), encouraging firms to make loans (debt financing)
○US financial sectors have seen the biggest boom in rising real estate, bond, and stock markets
●consequences of QE
○QE is a claim to having money, does notreflect a real increase in US economy’s output
○endless QE will inevitably cause inflation
○if QE were to stop, stock, bond, and real estate markets would crash, possibly reversing benefits gained from QE
○while it is easy to increase the money supply, it is hard to reverse the process
INSTRUMENTS OF MONETARY POLICY
Open-Market Operations
●buying and selling of bonds by the central bank (CB) on the open market
●most important technique available
●exchange one asset (bonds) for another asset (deposits on chartered bank)
●if bonds are purchased from…
○chartered banks, then the CB pays by increasing deposits of chartered banks at the CB, therefore reserves of chartered banks increase
○general public, then the CB pays by issuing to the sellers cheques drawn on the CB, cheques are then deposited in chartered banks, which increases their reserves
○increased reserves increase money supply
●open-market purchases of securities by the central bank increases money supply
●open-market sales of bonds by the central bank decreases money supply
Changes in the Bank Rate
●bank rate: interest rate that the CB charges for loans or advances that it makes to chartered banks and other members of the Canadian Payments Association
●important indicator/signal to chartered banks of the monetary policy CB wants to pursue
●effects of a change in bank rate
○increased bank rate → more expensive to borrow money from CB → chartered banks keep larger cash reserves to avoid borrowing → ability to extend loans/expand deposits will be small
○decreased bank rate → less expensive to borrow money from CB → chartered banks keep smaller cash reserves → ability to extend loans/expand deposits will be increased
○increased bank rate usually → raised interest rates and restricted loans by chartered banks → decrease money supply
○decreased bank rate usually → decreased interest rates and less restriction on loans by chartered banks → increase money supply
●note: Canadian chartered banks don’t often borrow from CB, it’s a last resort
Moral Suasion
●influence CB exerts on chartered banks to enlist their support in achieving specific objectives of monetary policy, but without legal obligation
●fewer chartered banks = easier to maintain channels of communication = more effective
LIMITATIONS OF MONETARY POLICY
●recessions/depressions render expansionary monetary policy ineffective, as households and firms may not want to borrow money if they are pessimistic about the future
●depends on response of chartered banks and public
●timing: recognition lag (realization of problem), decision lag (take a significant amount of time to reach a decision about what to do), implementation lag (delay between implementation and effect of monetary policy)
●significant amount of investment may be financed out of retained earnings rather than through borrowing from banks and other lending institutions (therefore interest rate policies have little to no effect on the investment decisions of the firms)
CITATIONS (MLA)
Amadeo, Kimberly. "11 Causes of a Recession." The Balance. N.p., n.d. Web. 01 June 2017. <
Cox, Jeff. "$12 Trillion of QE and the Lowest Rates in 5,000 Years ... for This?" CNBC. CNBC, 13 June 2016. Web. 02 June 2017. <
ChrisMartensondotcom. “The Crash Course - Chapter 10 - Quantitative Easing” Online video clip. Youtube. Youtube, 22 Aug. 2014. Web. 02 June 2017.
James, Elijah. Macroeconomics: a problem-solving approach. 5th ed. Pearson Education, 2000.
"GCSE Bitesize - Weimar - Crisis of 1923." BBC. BBC, n.d. Web. 01 June 2017. <
"Monetary Policy after the Crash Controlling Interest." The Economist. 21 Sept. 2013. Web. 01 June 2017. <
Staff, Investopedia. "Contractionary Policy."Investopedia. 28 Apr. 2016. Web. 05 June 2017.
Staff, Investopedia. "Expansionary Policy." Investopedia. 27 Feb. 2015. Web. 05 June 2017.
The Economist. “The Economist explains: Quantitative easing” Online video clip. Youtube. Youtube, 28 September 2012. Web. 02 June 2017.