Question

In order to support the Canadian dollar, the Bank of Canada buys an amount of Euros...

In order to support the Canadian dollar, the Bank of Canada buys an amount of Euros from some major commercial Canadian banks (a type of operation the Bank of Canada rarely undertakes).

a. What is the immediate and the long-term impact of this operation on the money supply?

b. If the Bank of Canada does not wish that the currency swap influence the money supply, what does it have to do?

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Answer #1

a.The immediate impact of this operation is that there will be an increase in money supply in the economy as a result the exchange rate will decrease and the currency will appreciate. In the long term as the domestic currency appreciates the demand for export falls and demand for import rises as exports become expensive and imports become cheaper and the domestic currency will depreciate as demand for foreign exchange increases.

b. If the Bank of Canada does not wish that the currency swap influence the money supply then it can let the domestic money supply increase by purchasing bonds and exchange rate wouldn't be disturbed and the domestic money supply will not decrease

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