Impact of open market operations by Bank of Canada and describe the monetary transmission mechanisms due to expansionary monetary policy.
1. Define an "open-market operation"
2. Assume Bank of Canada (BOC) purchases $100 million worth of government bonds from a chartered bank. Assume BOC imposes 5% legal reserve requirement ratio to the banking system. Write two balance sheets, one for BOC and other for chartered bank, illustrating the initial effect of Bank of Canada's purchase of bonds.
3.Now use information given in part(b) and write down the final balance sheet of the chartered bank i.e. the final effect of BOC's purchase of $100 m bonds on the chartered bank.
4.Suppose that money market is initially in equilibrium i.e. M/P = L = kY + hi. Now assume government reduced taxes which increases equilibrium income (Y). Draw a money market diagram to show the effect of increase in income on the interest rate.
5.Assume the money market is equilibrium. Now, suppose price level in the economy falls which affects the real money balances. Show graphically how does the change in real money balances affect interest rate.
6.The monetary transmission mechanism is the channel by which monetary policy is translated into changes in aggregate demand. Discuss fully how the monetary transmission mechanisms operate. Also, explain the conditions within the monetary transmission mechanism under which the impact of expansionary monetary policy on aggregate demand will be (i) highly effective (ii) virtually ineffective.