Question

Discuss the policy instruments that the Bank of Canada can employ to:

i) Control inflation

ii) Stimulate economic expansion

Answer 1

a) To control inflation the Bank of Canada can take several steps:

• Increase the reserve rates: A reserve rates are the amount of money the bank has to keep with them all the time and this amount can't be lend. IF the reserve rates are high the banks will have to keep funds with them and they can't those funds. This will reduce the amount of credit they can generate. Les credit means less investment and less demand.
• Sell the bonds in the open market: Selling bonds in the open market will absorb excess liquidity from the market and leave less money in hands of people this will decrease the demand in the economy and reduce inflation.
• Increase the discount rates: These are the rates at which the banks lend funds to commercial banks if these rates are high banks will take less money from central banks and their credit generation will be less. reducing investment and demand in the economy.

b) Stimulate economic expansion: To stimulate economic expansion the banks can follow easy money policy which will be just the opposite of the step taken above by the banks.

• They will buy more bonds fro the market increasing money supply.
• They will reduce the reserve requirement in the economy and reduce the discount rate giving easy money for the bank to lend and create credit.