Macroeconomics Assignment

ECON 5100 – Section A

November 24th, 2014

Assignment #2 – Macroeconomics

Question 1 – Write a short essay in support of the view that the Bank of Canada might have to increase interest rates over the next six to twelve months.

The goal of the Bank of Canada is to keep “inflation low, stable and predictable”. It sets the inflation target at around 2%, within the range of 1 to 3%. The reason for that is that a high inflation rate would be detrimental to consumers if income does not rise as the same rate as price. On the other hand, an inflation rate too low could prevent people and businesses from spending as they are expecting prices to decrease, which would lead to depressed economic conditions.

The Bank “carries out monetary policy by influencing short-term interest rates. It does this by raising and lowering the target for the overnight rate.” The effect of the Bank’s actions take time to have an impact on the economy. This is why they are looking ahead to predict the trend of inflation.

If the inflation is set to go outside of the range of 1-3%, the Bank of Canada would raise interest rates. The effect of the change works through the transmission mechanism. The interest rate has an impact on the credit, if the interest rate increases, other things being equal, the demand for credit should diminish. This should have an impact on the demand for goods and services. A lower aggregate demand should lead to lower inflation.

As reported by Statistics Canada, Canada’s annual inflation has spiked at 2.4% in October. The Consumer Price Index (CPI) is composed of eight major components. Seven of them had higher rates in October than in September. If the inflation keeps rising in this trend, the Bank of Canada could go ahead and increase interest rates in order to prevent inflationary pressures.

Question 2 - Write a short essay in support of the view that the Bank of Canada is not likely to change interest rates over the next six to twelve months.

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