Question

Due to pandemic (Covid19) that canada is facing along other countries around the world, the central bank of canada is following an expansionary monetary policy by significantly increasing the money supply. At same time, the benchmark interest rate remained at 0.25%. What might be the repercussions of these decisions for the whole Canadian economy

Answer 1

Introduction

The Corona Virus Pandemic is causing great concerns among economists over its short term and long-term problems which the economy is most likely to face. The demand for goods and services except for those which are necessary for business is declining sharply. The resultant is that the gross domestic product is also falling and so are the prices.

Recession is bad for any economy, but as long as it is cyclical in nature, it may be handled with policy decisions. This recession is caused due to reasons beyond simple economics and thus requires serious measures which need to be long term to maintain price stability and to promote growth in the society.

Government & Central Bank Measures: -

Whenever, an economy goes through a recession cycle, the government of the day tries to control it by expanding the monetary base or supply of money in the country. The Central Bank of Canada would also take serious measures to ensure that the economy can return back to its normal levels.

The government of the day, significantly reduces the taxes which it charges from people. The resultant is that people now have more currency available with them and this increases their spending capacity significantly. The government can also increase their spending to improve the supply of money in the economy. For example, the government hands, out contracts to private players which increases their monetary circulation and resultant demand from the same gives rise to employment opportunities.

The Central Bank on its part regulates the interest rates which the commercial banks charge and changing the same to a lower level i.e. 0.25% would mean that loans would become cheaper for producers as well as consumers and the overall demand in the country would come back to its normal position.

Further, the Central Bank can also purchase bonds and supply the economy with money or reduce the minimum cash requirements which is also known as the cash reserve ratio which helps the bank have more working capital for itself.

Effects and Graph: -

The effects of all these can be explained with the help of the following graph: -

Here in the example we see how the price of the goods change with the government’s intervention. The Reduced Quantity rises to the right and the aggregate demand for goods and services increase. The resultant is that the supply side also increases and the equilibrium shifts back to its original position.

These effects are sure to happen, once the economy re opens post the corona crisis as people will increase their current demand with reduction in interest rates and other similar measures as mentioned above.

Please feel free to ask your doubts in the comments section if any.