Monetary Policy - Money and interest rates - monetary policy and interest rate

3 important questions on Monetary Policy - Money and interest rates - monetary policy and interest rate

What happens when the BOC increases the money supply? How can the CB determine the interest rate?

The interest rate decreases, and by adjusting the money supply central bank can determine the interest rate

What is the process by which the central bank changes the money supply

  • The central bank sets the target for the overnight rate, which is the desired level for the overnight rate .
  • then it adjusts money supply by buying and selling treasury bills until the overnight rate reaches the target rate.

What can the central bank do to increase interest rate from the point below and to the right of the equlibrium MS=MD curve

  • it has to decrease money supply
  • The central banks makes an open market sales of treasury bills
  • this means they sell bonds and remove cash from economy, less money in the economy
  • leads to an decrease in the money supply via the multiplier
  • there will be a leftward shift in the (vertical) money supply
  • the equilibrium interest rate moves up to the target rate
  • the interest rate rises
  • quantity of money demanded decreases, and the quantity of money supplied increases

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