Csc chapter 4: economic theroies

Rational Expectatio: rational thinkers and evaluate the consequencs of a

government policy decision
Government cuts taxes to boos spending, if consumers are rational they will
save to pay more for higher future taxes
Evaluate the government intentions and negate it
Keynesian theory: direct government intervention as a means of acheviing
economic growth and stablitiy
Increase spending and lower taxes during recession
Monetarist theory: economy is inherently stable and left to its own self adjusting
mechanism, instability in the money supply is the major cause of inflation
Let money supply equal to the economys long run growth rate, controlling
inflation as the main policy goal creates a foundation for the economy to
grow at optimal rate
Supply side economics: market should be left on its own and government
intervention minimum,
FISCAL POLICY
Government powers to tax and spend to hit economic goals like full
employment
Both provincial and federal, federal is responsible for employment insurance,
defence old age, security, veterans affairs
Provincial governemnts: health, education and welfare
Some are similar, transfer payments to the priovincial from federal to pay for
health, education and welfare
Federal budget
Usually in feberary, finance minister presents fiscal year april 1 st to march 31st
Budget balance is to equal its revenues less total spending, revenue collected
for the year to balance
If a government predicts a deficit the amount projected n the budget may
differ from what the government actually borrows
Fiscal policy
Affects spending: highways, goods and services. Taxes: direct taxes, sales
taxes etc.
Monetary: exchange rates, interest and money supply
Fiscal: taxation and spending

Role of bank of Canada

1. Regulate credit and currency in the best interest of economic life of nation
2. Control and protect the external value of national monetary unit 3.
Mitigate by its influence in fluctuations of production
Does not specifiy manner by which pursue objectives, it administers policy
independent of day to day government interventions
Fluctiatons of the bank of Canada
Act for the government to issue and remove bank notes
Act as fiscal agent ex. Advise government
Administer deposit accounts and funds, accounts with the BOC and chartered
bank
Advises on price, yield and other features to make federal securities
marketable
Conduct monetary policy
Bank of Canada act empowers bank to: buy sell gold or foreign exchange,
maintain deposits with other banks
Debt management: new debt issues and major undertakings. Minister of
finance is responsbiel for debt management programs but relies on the bank
for advice and implementatopm
Monetary Policy
-. Improve performance of the economy by regulating the growth in mully supply
and gredit, to ensure money can play a vitral role
-. Preserve the value fo money by promiting sustained economic growth with price
stability
-if inflation approaches the top of the target ranges this sually indicates the demand
of goods is rishing and interest rates rise and vice versa
-in the long run, inflation is linked to the rate of growth of money and credit, through
its influence over short term and long term rates
Implementation
-. Overnight rate: a marketplace where major financial isntituions lend each other
money nightly
*currently 60 basis or half a percent, each day it sets it between say 5% and 5.5%
-Bank rate: minimum rate at which the bank of Canada will lend money on a short
term rate, similar to target overnight rate
Open market operations

-. Special purchase and resale agreements: to relive undesired upward

pressure on overnight financing
Ex: if upper limit of the operating band is 4.25 while overnight trades at 4.5, it does
not make sense for institutions to borrow at at the higher overnight rate
-offers to purchase government securities from a primary dealer to sell them back
at a predetermined price
-when bank purcahses from instituitions they pay the institution cash for the
securities
-next day, bank receives money in exchange for the securties returning
-sale and repurchase agreement: used to offset undesired downward pressure
on overnight financing costs, if lower limit is 3.75 while overnight is 3.5 financial
instituions would prefer BOC rate
-bank sells government securities to chartgered banks with an agreement to
repurchase
-bank is borrowing money form chartered bank when it sells securities
-this is to reinforce the lower the limit or floor the operating hand
-bank will always lend at upper and borrow at lower, makes no sense to trade in
overnight market rates outside this band
Drawdowns and redposits: the bank of Canada can transfer finds from the
governemnts account at the bank to its account at the chartered banks or from the
government accounts, this is to influence short term interest rates
-drawdown: transfer of deposits to the bank from chartered bank, draining supply of
cash balances, depcreases deposits and reserves, increase interest rates
-redposit: opposite
Failed policy
-. Ecnomy slow to react to plocy changes, may not be effective
-no need because of natural equilibrium
-interest payments big expenditure
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