Monetary and Fiscal Policy Practice Flashcards

A set of 50 vocabulary flashcards covering the Bank of Canada's monetary policy tools and the principles of fiscal policy as discussed in Lecture Chapters 22 and 23.

Bank of Canada Main Goal

To maintain low and stable inflation, specifically targeting a rate of $2\%$.

Bank of Canada Independence

The Bank is largely independent to avoid political pressure, which helps keep inflation low.

Overnight Rate

The interest rate that banks pay to borrow or lend funds to each other overnight.

Operating Band

A range of $\pm 0.25\%$ around the target overnight rate.

Effect of Falling Interest Rates

Spending increases, which leads to an increase in the economy and GDP.

Effect of Rising Interest Rates

Spending decreases and saving increases, leading to a decrease in the economy and GDP.

Effect of Adding Overnight Funds

When the Bank adds overnight funds, the overnight rate decreases.

Effect of Removing Overnight Funds

When the Bank removes overnight funds, the overnight rate increases.

Repo

A transaction where the Bank of Canada sells a bond and buys it back the next day.

Buying Government Bonds

A monetary tool where the Bank buys bonds to decrease interest rates.

Selling Government Bonds

A monetary tool where the Bank sells bonds to increase interest rates.

Forward Guidance

The Bank announces future policy intentions to influence economic expectations.

Quantitative Easing (QE)

A policy where the Bank of Canada buys large quantities of long-term government bonds.

Quantitative Easing Effect

Long-term interest rates decrease, which increases the volume of long-term loans.

Monetary Policy Ripple Effect

Changes in the overnight rate affect other interest rates, spending, saving, and the value of the Canadian dollar.

Interest Rates and Net Exports (NX)

When Canadian interest rates fall, investment in Canada decreases, leading to lower imports, higher exports, and an increase in NX.

Monetary Policy Step 1

Economic Projections.

Monetary Policy Step 2

Major Briefing.

Monetary Policy Step 3

Policy Recommendations.

Monetary Policy Step 4

Making the Decision.

Monetary Policy Step 5

Communication.

Annual Rate Decisions

The Bank of Canada makes $8$ interest rate decisions each year.

Inflation Target Buffer (Real Wages)

A $2\%$ inflation target makes it easier for firms to decrease real wages.

Inflation Target Buffer (Interest Rates)

A $2\%$ inflation target provides more room for the Bank to decrease interest rates when necessary.

Inflation Target Reason (CPI)

The Consumer Price Index (CPI) tends to overstate inflation, justifying a target above $0\%$.

Policy Rule Formula

$$\text{Overnight Rate} - \text{Inflation} = \text{Neutral Real Rate} + \frac{1}{2}(\text{Inflation} - 2\%) + \text{Output Gap}$$

Neutral Real Rate

A component of the policy rule formula representing the real interest rate when the economy is at full employment and inflation is on target.

Output Gap

The difference between actual GDP and potential GDP, included as a variable in the policy rule formula.

Fiscal Policy

The government's use of changes in spending and taxes to stabilize the economy.

Expansionary Fiscal Policy

Increasing government spending and decreasing taxes to increase Aggregate Demand (AD) and GDP.

Expansionary Policy Context

This policy is used during a weak economy or a recession.

Contractionary Fiscal Policy

Decreasing government spending and increasing taxes to decrease Aggregate Demand (AD) and GDP.

Contractionary Policy Context

This policy is used when the economy is overheating.

Direct Government Spending

Government purchases of goods and services, such as schools, highways, and the military.

Indirect Government Spending

Government transfers to households, which the households then spend.

Multiplier Effect

The phenomenon where an initial amount of government spending creates additional rounds of spending.

Fiscal Policy Time Lags

Delays in discretionary policy due to the time needed to recognize a problem, pass the policy, and spend on projects.

Automatic Stabilizers

Taxes and benefits that automatically change with the state of the economy.

Automatic Stabilizers in a Recession

Taxes automatically decrease while benefits and Employment Insurance (EI) increase.

Automatic Stabilizers in a Boom

Taxes automatically increase while benefits decrease.

Crowding Out

A situation where government spending or borrowing causes a decrease in private investment.

Crowding-out Chain

$$\text{G} \uparrow \rightarrow \text{government saving} \downarrow \rightarrow \text{loanable funds supply} \downarrow \rightarrow \text{interest rate} \uparrow \rightarrow \text{private investment} \downarrow$$

Monetary Policy Implementation Speed

Monetary policy is quicker to implement than discretionary fiscal policy.

Fiscal Policy Advantage

Changes in government spending or taxes can be targeted at specific industries or geographic areas.

Zero Lower Bound

The point at which interest rates cannot be cut any further, making fiscal policy critically important.

Discretionary Fiscal Policy

Deliberate and temporary changes made by the government to spending or taxes.

Government Debt

The total accumulated amount of money that the government owes.

Budget Deficit

A status occurring in a single year when government spending exceeds tax revenue.

Budget Surplus

A status occurring when government revenue exceeds spending, which can be used to repay debt.

Net Government Debt

The portion of government debt owed to individuals, businesses, and other governments.