Suppose the Bank of Canada Strictly Followed a Rule of Keeping

question 28

Essay

Suppose the Bank of Canada strictly followed a rule of keeping money supply at $900 billion. This level of money is consistent with the economy's initial general equilibrium.
a. Assume that GDP has increased. How will the interest rate change?
b. Assume that banks have introduced checking accounts that pay interest. How will the interest rate change?
c. What are the effects of the Bank's money targeting policy on the economy?
d. If the Bank decides to target the interest rate instead of money, what will be the effects of the shocks in a and b on aggregate demand?
e. Compare the effects of the two money targeting and the interest rate targeting policies on the economy. Will the money targeting policy make the aggregate demand more stable or less stable than it would be if the interest rate were constant?

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Definitions:

Floating-Rate Bonds

Bonds whose interest payments fluctuate with market interest rates.

Coupon Rate

The annual interest rate paid on a bond, expressed as a percentage of the bond's face value.

Market Interest Rates

The prevailing rates at which borrowers are able to obtain loans and lenders receive compensation for their funds in the financial market.

Inflation Protection

Strategies or financial instruments designed to protect investors from the loss of purchasing power due to inflation.