Monetary and Fiscal Policy Flashcards Aug 10th

Flashcards covering vocabulary and key concepts from pages 1-8 of the Monetary and Fiscal Policy lecture notes.

Bank of Canada

The central bank created by Parliament in 1934 with a current mandate to maintain a low and stable inflation target of $2\%$.

Target overnight rate

The interest rate banks pay to lend or borrow from each other, or from the Bank of Canada, within an operating band of $0.25\%$ above or below the target rate.

Overnight repurchase agreement (repo)

A tool used by the Bank to decrease funds in the overnight market by selling a bond to a financial institution with an agreement to buy it back the next day at a higher price.

Open market operations

The Bank's method of buying and selling government bonds in open financial markets to either raise or lower interest rates.

Forward guidance

A tool used to indicate the future course of monetary policy to influence market expectations of future interest rates.

Quantitative easing

The purchase of large quantities of longer-term government bonds to put downward pressure on long-term interest rates and increase the supply of long-term loans.

Governing Council

The body at the Bank of Canada that makes 8 interest rate decisions each year following a established 5-step process.

Neutral interest rate

A component of the policy rule-of-thumb formula representing the real interest rate consistent with the economy at potential output; in the provided example, it is $0.5\%$.

Policy rule-of-thumb

A formula defined as $\text{Overnight rate} - \text{Inflation} = \text{Neutral real interest rate} + \frac{1}{2} \times (\text{Inflation} - 2\%) + \text{Output gap}$.

Countercyclical Fiscal Policy

The use of government spending and tax policies to counteract the business cycle effects to keep the economy close to potential GDP.

Expansionary fiscal policy

A policy used when output is weak, involving increased spending and lowered taxes to boost aggregate demand and raise GDP.

Contractionary fiscal policy

A policy used when the economy is overheating, involving decreased spending and increased taxes to weaken aggregate demand and lower GDP.

Direct fiscal policy

Government purchases such as spending on military equipment, schools, and highways.

Indirect fiscal policy

Transfer payments that boost aggregate expenditure when households spend they money received, such as the Canadian Emergency Response Benefit (CERB) during the pandemic.

Automatic stabilizers

Fiscal policies like progressive tax systems and government support programs that adjust as the economy expands or contracts without deliberate action by policymakers.

Progressive tax system

An automatic stabilizer where individuals drop into lower tax brackets during a bust (allowing more spending) and rise into higher brackets during a boom (spending less).

Discretionary fiscal policy

Policy that involves temporary changes to spending or taxes to boost or slow the economy, which can be subject to substantial time lags.

Crowding out

A decline in private investment caused by higher interest rates resulting from an increase in government spending.

Zero lower bound

The point where the Bank cannot cut short-term nominal interest rates any further, leaving fiscal policy as the primary stabilization tool.

Government debt

The total accumulated amount of money that the government owes, representing the accumulated stock of borrowing at a point in time.

Budget deficit

The difference between spending and revenue in a year where spending exceeds revenue, which adds to the total debt.

Budget surplus

The difference between spending and revenue in a year where revenue exceeds spending, which can be used to repay debt.

Net government debt

The debt that the government owes specifically to individuals, businesses, and other governments both domestically and abroad.

Crisis of confidence

A risk where a perceived risk of non-payment leads lenders to charge higher interest rates, making it difficult for the government to repay loans.

Vicious cycle of deflation

A risk of targeting $0\%$ inflation where people expect future prices to fall, leading to continuous price decreases.