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ECON 3440 (Section M)

Summer 2022 (S2)

Active Learning Activities: ALA 2 -- Solutions

Question 1

Explain how the Bank of Canada’s operating procedures limit fluctuations in the overnight interest rate. Draw a diagram for the market for reserves (settlement balances) to support your explanation.

See Application on pages 398-399 and Figure 16-3 of the textbook (7th ed.) for a detailed explanation. Or,

See Application on pages 398-399 and Figure 16-3 of the textbook (6th ed.) for a detailed explanation.

Question 2

What is SPRAs? Explain how a SPRA operation helps the Bank of Canada in achieving the target overnight rate. Using the T-accounts, illustrate the effects of SPRAs on the balance sheets of the Bank of Canada and Primary Dealers.

See Application on pages 404-405 and Figure 16-7 of the textbook (7th ed.) for a detailed explanation. Or,

See Application on pages 404-405 and Figure 16-7 of the textbook (6th ed.) for a detailed explanation.

Question 3

What are the advantages and disadvantages of quantitative easing as an alternative to conventional monetary policy when short-term interest rates are at the zero lower bound?

Since short-term interest rates cannot be lowered below the zero bound in this environment, conventional           monetary policy would be ineffective. Thus, the main advantage of quantitative easing is that purchases of         intermediate and longer-term securities could reduce longer-term interest rates, increase the money supply          further, and lead to expansion. One disadvantage of quantitative easing is that it may not actually have the effect of increasing economic activity through greater loans and monetary expansion: if credit and financial markets    are significantly damaged, banks may simply hold the extra liquidity as excess reserves, which would not lead   to greater loans and monetary expansion.

Question 4

Explain how the Bank of Canada keeps the rate of inflation from falling below the target range. See pages 400-402 and Figure 16-5 of the textbook (7th ed.) for a detailed explanation.

Question 5

Explain the effect of an increase in reserve requirements by Fed on the federal funds rate. Draw a diagram for the market for reserves (settlement balances) to support your explanation.

See pages 424-425 and Figure 16- 16 of the textbook (7th ed.) for a detailed explanation.

Question 6

Explain how pursuing a nonborrowed reserves target by the Bank of Canada could cause the overnight interest rate to fluctuate. Draw a diagram for the market for reserves (settlement balances) to support your explanation.

See pages 451 and Figure 17-3 of the textbook (7th ed.) for a detailed explanation.

Or,

See pages 449-450 and Figure 17-3 of the textbook (6th ed.) for a detailed explanation.

Question 7

Explain how pursuing an overnight interest rate target by the Bank of Canada could cause the quantity of nonborrowed reserves to fluctuate. Draw a diagram for the market for reserves (settlement balances) to support your explanation.

See pages 451-452 and Figure 17-4 of the textbook (7th ed.) for a detailed explanation.

Or,

See pages 450 and Figure 17-4 of the textbook (6th ed.) for a detailed explanation.

Question 8

Assume that the amount of dollar (domestic) assets is fixed in the foreign exchange market. Explain the effects of an increase in the domestic interest rate, holding all other factors constant, on the exchange rate. Draw a diagram for the foreign exchange market to support your explanation.

See pages 473-474 and Figure 18-3 of the textbook (7th ed.) for a detailed explanation.

Or,

See pages 469-470 and Figure 18-4 of the textbook (6th ed.) for a detailed explanation.

Question 9

Assume that the amount of dollar (domestic) assets is fixed in the foreign exchange market. Explain the effects of an increase in the foreign interest rate, holding all other factors constant, on the exchange rate. Draw a diagram for the foreign exchange market to support your explanation.

See pages 473-475 and Figure 18-4 of the textbook (7th ed.) for a detailed explanation.

Or,

See pages 470-471 and Figure 18-5 of the textbook (6th ed.) for a detailed explanation.

Question 10

Assume that the amount of dollar (domestic) assets is fixed in the foreign exchange market. Explain the effects of an increase in the expected future exchange rate (i.e., an increase in the expected appreciation of the domestic currency), holding all other factors constant, on the exchange rate. Draw a diagram for the foreign exchange market to support your explanation.

See pages 474-476 and Figure 18-5 of the textbook (7th ed.) for a detailed explanation.

Or,

See pages 471-472 and Figure 18-6 of the textbook (6th ed.) for a detailed explanation.