Question

      In view of the Coronavirus epidemy, the Bank of Canada along with most advanced nations’ central banks has cut its policy interest rate by 1.5% to 0.25%.

1. Explain the Bank of Canada’s intention and motive behind this policy.
2. Employing the model of interest parity, discuss with the help of a diagram the expected impact of these interest cuts on the exchange rate (Canadian dollar).
3. Now explain how the expected change in the Canadian dollar is hoped to affect Canada’s net exports (NX) and Canada’s GDP.

Answer 1

A.

The intention and motive of Bank of Canada is to encourage consumption and investment spending as borrowing becomes cheaper in the market with decrease in rates. It is supported by the increase in money supply. So, it will give boost to the economy and real GDP will either increase or maintained at the satisfactory level in the wake of COVID-19 pandemic.

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B.

The exchange value of Canadian dollar will decrease. It will lead to the more amount of Canadian dollar required for one unit of USD or Euro or other major currency.

Above diagram shows the movement from S to S1 when supply of Canadian Dollar increases in the market and exchange rate decrease.

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C.

It will makes exports to be cheaper and imports to be expensive. As a result, export increases and import decreases. It makes NX to increase in the economy, leading to increase in real GDP of Canadian economy.