Can the Bank of Canada sterilize its open-market operations with foreign exchange market operations?
lura asked:
Explanations about how monetary policy affects Canada’s aggregate demand are incomplete if we do not consider the effects of perfect capital mobility and the effects of net exports. These two effects are crucial for a small open economy like Canada.
Explanations about how monetary policy affects Canada’s aggregate demand are incomplete if we do not consider the effects of perfect capital mobility and the effects of net exports. These two effects are crucial for a small open economy like Canada.
Suppose the world interest rate is 4%, and Canada’s interest rate is initially equal to 4%.
7.3. Suppose the Bank of Canada wants a fixed exchange rate against the U.S. dollar but also wants to reduce the money supply. Can the Bank of Canada sterilize its open-market operations with foreign exchange market operations?
A. Yes
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October 6th, 2008 at 12:11 am
B. No - because sterilization will be offset by initiated capital flows due to difference in interest rates.
P.S. I wouldn’t call Canada small open economy (in perfect defenition) because of it’s effect on world economy - It produces around 2.6% of world output.