When the Bank of Canada uses
A. supply of bonds decreases.
B. demand for money increases.
c. supply of money increases.
D. supply of money decreases
E, demand for money
The correct answer and explanation is:
The correct answer is C. supply of money increases.
When the Bank of Canada engages in monetary policy actions such as open market operations (OMO), one of the key tools used to influence the economy, it impacts the money supply. In an expansionary monetary policy, the Bank of Canada buys government bonds from the market. This process increases the supply of money in the economy.
Here’s how it works:
- Open Market Operations: When the Bank buys bonds, it credits the accounts of the banks or financial institutions that sell the bonds. The act of crediting these accounts means the banks now have more reserves in the banking system.
- Impact on the Supply of Money: With more reserves, banks have more money to lend out to businesses and consumers. This action increases the overall supply of money circulating in the economy.
- Lower Interest Rates: The increase in the supply of money can also lead to a decrease in interest rates, as the increased reserves make borrowing cheaper for businesses and consumers. This, in turn, can stimulate spending and investment.
- Effect on Inflation: An increased money supply can lead to higher inflation if it outpaces economic growth. However, in the short term, it helps stimulate economic activity, especially if the economy is in a downturn.
To sum up, when the Bank of Canada buys bonds, it injects money into the economy, which directly increases the supply of money. This tool is typically used to stimulate economic growth, lower unemployment, and increase inflation when necessary.