Monetary policies get formulated to maintain the economy of a country in a stable condition within the changing economic variables. It involves the control of the supply of money within the country. The regulation of the ratio of interests offered by banks on lenders and borrowers also gets controlled by the monetary policies. The monetary policies also ensure the viability of money within the country by the control of its exchange rates. The main reason for these roles is to control inflation within the country. The rising prices of commodities within the country have various effects on the spending habits of consumers and the various investments within the country. The stabilization of the currency of a particular country also raises the need for the monetary policies within the countries. Consequently, this is to increase the confidence of international parties in the economy of a country.
Amongst the objectives of formulating a monetary policy is to ensure effective economic growth with the regulation of interest rates within the country. This encourages the spending and investment of the household and businesses within a country. Price stability within the country also gets controlled by the monetary policy; therefore, it bridges the gaps between the wealth categories in the country. This also gets done by regulating the ease of acquiring money within the economy. Exchange rate stability is also a key objective of the monetary policy to maintain confidence in the economy by the international community. The Balance of Payments within a country enables the banks within a country to determine the need for money within the country. A deficit in the balance of payments calls for an increase in the amount of money in circulation and a surplus implies an excess of currency circulation. The monetary policies should ensure equilibrium in the Balance of Payments (BoP). The prevalence of involuntary unemployment is an issue that monetary policies try to minimize. In this case, the monetary policies aim to attain full employment.
The Bank of Canada has had commendable monetary policies over the years. This became evident with the stability of the country over inflation-filled periods and various financial crises. The recent global recession got dealt with in an efficient way, and the recovery has been remarkable (Poschmann).
The Bank of Canada based its monetary policies on Professor Milton Friedman’s principles of monetary policies. This was after an economically eventful scene in Canada during the 1980s that saw to the considerable rising and falling of interest rates in Canada due to inflation. Friedman insisted that inflation is a phenomenon that cannot be expended in the formulation of monetary policies in all aspects. Moreover, this came with the realization that banks all over the world contributed significantly to the explosion of inflation all around the world. This came with a vast number of catastrophes to the Canadian economic welfare. Furthermore, there was a massive loss of jobs and depreciation of the income of Canadians (Walker).
These experiences led to a rapid adaptation to the situation for the Bank of Canada as it adopted Friedman’s policies. The lessons learned from the financial crisis led to the thwarting of the policies of the Mulroney government that were of a spendthrift nature and had thus resulted in the inflationary result seen within the country. John Crow took the reins of power within the bank to ensure the complete assimilation of these policies. The policies also succeeded in limiting inflation. However, the disagreements between him and the government saw to the immature termination of his tenure that bore the most beneficial policies in the Bank of Canada.
The inflation performance of the Bank of Canada became efficient with the adoption of a flexible exchange rate system. This makes the monetary policies of the country independent of such factors as inflation. This made the Bank of Canada the best performer in inflation in the world following the current global recession. The monetary policies in Canada center on the capacity of the country as labor markets are tightening and reducing the inflation rates that even with the exclusion of the volatile fuel prices still stands at a high percentage (Antunes).
In the 2008 global recession, Canada lost an approximate 70,000 jobs and the GDP fell considerably. The recession had led to the loss of full employment that had then been set by the monetary policies by 2008. The unemployment rate is more than 6% in the country, and this has stunted the economic welfare of the citizens. The growth rate of the GDP is slow but on an upward progression. Currently, it stands at a mere 2,7%. The labor markets are mainly tightening for aged citizens. The youths are getting adopted into employment at a faster rate than the senior citizens in Canada with increasing job openings from them as retirement beckons for most workers in the job fields (Hodgson).
The consideration of the spending habits in formulating the monetary policies in Canada is significant as consumers have become extremely strict on acquiring goods and service. This combined with the increased debt accrued against the households in the country. The deficits on the balance of payments increases as the buying power of purchasing power parity of the country have depreciated significantly due to loss of consumer confidence. The lack of investment as was noted before the recession and its related inflation led to the increase in this deficit in the country leading to the reduction of the success of the sectorial development with the increased acquisition of foreign goods that are cheaper and thus suitable to the consumers’ conservative spending habits.
The independent monetary policies in Canada that enabled the interest rates within the country to remain low despite the inflationary effects of the recession on the global economy was the key reason for the countries remarkable recovery. The monetary policies did not develop in congruence with inflation. The interest rates are low on a short-term basis and thus the need to save within the Bank of Canada does not benefit the citizens in any way. The interest money gains within the bank show a negative short-term rate, because, in any case, the interest earned gets taken as a tax. The interest rate lies at 1,5% after a reduction of 75 basis points on the interest rate following the recession. The inflation creates a much fruitful interest for the Canadians compared to its banks thereby reducing the need for saving. There are various reasons as to why the monetary policies in Canada insist on such an interest rate that is independent of the effects of inflation. This is among the strong points of the monetary policy of Canada as it considers the subsequent effect of the interest rates on money, which the lenders lend the bank or borrowers get from the bank.
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External risks are among the reasons why the interest rates remain low. The extremely volatile economic markets could have a detrimental effect on the economy for the country if the interest rates get designed to match the inflation. It is important to mention that the stock market has the ability to increase or drop suddenly with inflation. Either effect of inflation on the equity market could affect the economy in a hurtful way if the monetary policies also get designed in accordance with monetary policies. The defaulting in settling sovereign debt to the Europeans and household debts would be in question if the interest rates within the Bank of Canada got increased. The push of salary by inflation requires the regulation of the interest rates during the inflation to enable the speedy recovery to full employment within the country. This comes as the difficulty since paying workers gets reduced with low-interest rates as the interest from inflation does not get boosted by the Bank of Canada (The Bank of Canada).
The spending habits of the households in Canada got decimated considerably by the recession and the business investments also depreciated. The federal infrastructure program got halted due to these economic times. The Bank of Canada wants to increase the purchasing parity of the country as well as the urge to invest in these economic times. The increasing of interest rates would not encourage the households within Canada to take up debts and increase the consumer confidence within the country. The fiscal restraint inhibits the government from improving the infrastructure of the country. This has raised the need for investors to cover this deficit of investors. The low-interest rates increase the suitability of the country for investment as the credit situation is favorable.
The increase of the Bank rate in the event of an increased interest rate would increase ratings of the Canadian dollar. The US Federal Reserve has planned to slacken its monetary policies till about 2014, resulting in the lowest ever noticed funds rate in the US. An increase in interest rates in Canada would pile up pressure for the Canadian dollar to increase its value. This will result in the movement of a massive amount of capital into the country. The inflation prices will get maintained at a low scale. However, the local manufacturing industry will be hard hit. The attraction of investors into Canada with the increased will increase the competition for manufacturers and exporters within the country. This would carry on the eight-year plight of the manufacturing industry in Canada, and thus the monetary policies champion for low-interest rates despite the inflation.
These policies have shortcomings in reducing the interest rates to curb inflation due to the recession. These measures are not effective in the current conditions based on the current settings of the economic field of the world. The financial crisis creates cutting the interest rates ineffective in handling the economic problems if the balance sheets of the banks do not get properly balanced. This ensures that even though customers get cuts on their interest rates, the borrowers equally get a reduction of these rates. The financial crisis requires to be sorted out before these cuts get affected or else they will just cause further economic crises.
In addition, the credit situation in Canada, despite being least hit by the meltdown of financial sectors, the risk of defaulting borrowers still looms. Access to credit for most lenders and borrowers is still challenging. This makes this strategy in jeopardy as it will take time before the credit situation in the world stabilizes to enable the utilization of these cut interest rates.
The benefits of cutting interest rates require the patience of the country from the country. A period of 12-18 months is requiring for the strategy to begin working efficiently. The ability of the country to survive this period without breaking down is a crucial issue to consider before implementing such cuts.