Chapter 8 - Stabilization Policy

http://www.cbc.ca/money/story/2009/04/21/bank-canada-rate.html

Summary:
The Bank of Canada promises that the interest rate will stay the same until the middle of 2010. They decreased the overnight rate by a quarter of a percent so; the interest rate right now is 0.25%. Depending on the inflation rate, this will remain until the middle of 2010. The Bank of Canada is hoping that it will help stimulate the economy. No other bank in the world has done anything like this before. The recession in Canada is actually deeper than anticipated. In 2009 they believe that Canada’s economy will contract 3.0%. However, they expect an economic growth of 2.5% in 2010. Due to this promise from the Bank of Canada, chartered banks have been reducing their prime interest rates.

Connection
The connection between this article and text book is monetary policies. Money supply is a stabilization tool. Usually when interest rates increase or decrease, it will affect businesses and consumers. However, monetary policies have a limited effect. Sometimes the interest rate is inelastic, which means consumers do not respond to the changes in interest rates. This is not what we are seeing right now. The Bank of Canada has lower their interest rate even more, hoping it will get the economy moving again. They even assured the chartered banks that this rate will stay the same until the middle of 2010, depending on inflation rates. Therefore, the chartered banks of lowered their prime rate to 2.25%. Which means that the interest rates do not have an inelasitc demand right now.

Reflection:
Canada’s recession is deeper than it was anticipated. This made the Bank of Canada to do something that no other central banks do. They made a promise that the interest rate will stay the same. It certainly has an effect on chartered banks since they are already lowering their prime rates. Since interest rates are lowering, businesses should be investing again. Consumer spending should also increase thus more money will go into the economy. However, the question is when will this happen? How long would it take for this monetary policy to have an effect on the economy? Does the central bank need to introduce another monetary policy to get the economy moving again?