Lecture 15 - ECO100 - S2012

E when it decreases the bank rate it becomes less

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Unformatted text preview: mes less expensive for commercial banks to borrow when they are short of reserves Therefore, banks will worry less about the probability of being short of reserves and will decrease their desired cash reserve ratio Banks decrease their cash reserve ratio by giving new loans, thus increasing the public’s deposits and increasing the money supply © Gustavo Indart Slide 28 The Overnight Rate and the Money Supply When the Bank of Canada decreases the target for the overnight rate (i.e, when it decreases the bank rate), it indirectly causes the money supply to increase in it indirectly causes the money supply to increase in two ways Fi First, by causing commercial banks to reduce their desired cash reserve ratio Given the level of RE, commercial banks will the level of RE commercial banks will increase loans to the public and money supply will increase © Gustavo Indart Slide 29 The Overnight Rate and the Money Supply (cont’d) (cont’d) Second, banks generally react to the reduction in the bank rate with an immediate reduction in the rates (i) they charge on loans to their customers The prime rate is usually set at 2 percentage points prime rate is usually set at percentage points above the overnight rate Therefore, as i falls the demand for loans increases and as the demand for loans increases and so do the deposits of the public (D) As D increases, the reserve ratio of the banks (v) might fall below (overshoot) the desired level The commercial banks will then sell government bonds to the Bank of Canada to increase RE bonds to the Bank of Canada to increase RE and restore v to the desired level © Gustavo Indart Slide 30 The Bank of Canada and the Rates of Interest Source: P. Krugman, R. Wells and A. Myatt, Macroeconomics. © Gustavo Indart Slide 31...
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This note was uploaded on 03/28/2014 for the course ECON 100 taught by Professor Carr during the Summer '10 term at University of Toronto- Toronto.

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