Rationale Of Expansionary Monetary Policy Essay

Question:

Discuss about the Rationale of Expansionary Monetary Policy.

Answer:

Introduction:

Canadian economy is growing in a fast pace due to various reasons such as GDP, increasing employment rate and expansionary fiscal policy management. The economy of Canada experienced a growth rate in its GDP by 3.7 percent, which in turn increased the household expenditure by 1.1 percent. The county also experienced a growth in its exports by 0.2 percent in its fourth quarter. Other factors that is affects the growth rate of the Canada is its increasing population. Canada experienced n increase in its population from 34.9 million to 36.5 billion. The country also experiences a high literacy rate of 97 percent. Thus, the country experiences an increase in its growth rate by 2 percent. The overall positive environment of the country puts a positive impact on the demand for liquor. This is because people of the country are educated and has the purchasing power required to buy liquor. The high purchasing power f the consumer also shows that they love to lead a high-class life (Hall, Robert & Marc Lieberman, 2012).

From the above figure, it can be seen that due to the above-mentioned factors has put a positive impact on the demand for liquor. The aggregate quantity demanded for liquor has increased from Q to Q1. Such an increase is because of increasing living standard of the people and increasing preference for liquor. The change in aggregate demand for liquor is mainly due to changes in other factors rather than price (Baumol et. al., 2015). Thus, the price for liquor is unaffected in the above diagram. Moreover, the product Tequila is considered as a luxury item and thus, it has a relatively elastic demand. The demand for this product is not affected too much extent. With a change in the factors of the economy such as GDP rate, unemployment, purchasing power and the changing life style of the people the demand for liquor will increase but not to that extent (Wetzstein, 2013).

The country of Canada aimed at a GDP growth rate of 2 percent in 2017 and a inflation rate between 1 to 3 percent. According to the policy goals of Canada, the country has been able to achieve the growth rate of 1.5 percent and an inflation rate of 1.2 percent (Ryan-Collins, 2015). The monetary policy of the country had the objective of achieving a stable, predictable and low inflation economy. Thus, the country always aimed at two policy components such as inflation control policy and flexible exchange rate policy. In reducing inflation in the country the nation has also targeted a high interest rate policy on loan and mortgages.

From the above figure, it can be seen that Canada has experienced an increase in its GDP growth rate management in 2017 compared to its past years. It has a GDP growth rate of 2.7 percent in 2015which increased to 2.8 in 2016. Presently in 2017, the GDP growth rate of Canada increased to 3.7, which even exceeded the estimated growth rate of 3.6 percent. Thus, the economy of Canada is expanding at a faster rate (Svensson, 2015).

Figure 3 shows the trend in the inflation rate in Canada from 2015 to 2017. The company had a inflation rate of 1.5 in 2015 which increased by 1 percent to 1.6 in 2016. However, the policy maker of the country aimed to keep the inflation rate between 1 to 3 percent in 2017. According to the data of 2017 in the first two quarters, the country has been able to cut down its inflation to 1.2 percent by increasing its interest rate on loan and mortgages (Argy, & Nevile, 2016).

From the above figure and data, it is clear that Canadian economy has experienced an increase in its GDP and fall in its inflation rate over the past three years. The economy has been able to achieve the target growth rate and the inflation rate according to the policy of the country. However, on curbing the inflation the bank has increased the interest rate over loans and mortgages (Ekelund Jr, R.B. & H?bert, R.F). (2013. This has reduced the money in the hand of the people. On the other hand, the country has experienced an increase in the GDP growth rate over the last three years. This has put the consumers in a better condition. Thus, it can be seen that the country will experience an increase in the demand for liquor, as people are becoming rich and high living style. However, the aggregate demand will not increase to that extent as the government is curbing the money from the hands of the people to curb inflation (Mankiw, 2014). Thus, the data that is presented in the above question helps to give the same prediction as stated in question one. Liquor consumption is increasing in Canada at a relative rate even though the government is trying to curb the money from the hands of the people. This is because people of Canada are fun loving and like to lead a good life even with limited amount of money.

The GDP of the Canadian economy is very high. As a result of which people the purchasing power of the people will increase. The government will thus adopt deflationary fiscal policy to stabilize the economy. When the government adopts tight fiscal policy, there will be fall in the aggregate demand of liquor. The Government will raise the tax on liquor and thus it will increase the price of liquor. Thus, higher amount of taxes will reduce the spending of the consumers (Sims, 2016). This will also help the government to improve the deficit budget. When the government reduces its expenditure and borrowings, there is increase in the supply of funds in the credit market and thus the interest rate falls. This leads to crowding in effect on the economy. The exchange rate (MXP-CAD) in such a situation will increase and thus will be profitable for the Government (Bordo & Landon-Lane, 2013).

The expansionary monetary policy will make the consumption attractive compared to the savings. The products will become cheaper for the people of the other economies and it will help the exporters because the exports will become cheaper and it will also boost up the demand Moreover, these expansionary monetary policies will also increase the aggregate demand and thus boost up the economic growth (Bekaert, Hoerova, & Duca, 2013). There will be increase in money supply in the economy and thus fall in the interest rate. This low rate of interest will encourage the business firms to invest and the consumers will be attracted to spend more. Moreover low interest rate will make the borrowings cheaper. This will also lower the incentive to save of the people. The exchange rate (MXP-CAD) will fall if there is expansionary monetary policy. This will strengthen the current account thus weaken the financial economy. As the financial condition of the economy declines, the current account will improve and thus it will also improve the balance of trade of the country. Thus, the GDP will increase and it will lead to increase in the imports (Hommes, Massaro & Salle,2015).).

When the government adopts expansionary monetary policy, the exchange rate will fall. This will lower the quantity of imports and thus increase the exports when they are denominated in terms of CAD. This is because CAD will become cheaper for the export countries importing liquor from Canada. These will increase the sales of the domestic firms. The exports will increase when the sale of tequila in terms of Canadian dollar remains unchanged. The imported goods will become more expensive and thus this will lead to inflation in the economy (Cochrane, 2016).

When the government adopts deflationary fiscal policy, the exchange rate in terms of CAD will increase. The quantity of imports will increase and the exports will fall. This is because with an increase in the value of exchange rate CAD will become costlier for the foreign company importing Canadian liquor.The sales of the domestic firm will decrease when the value of the Canadian dollar remains unchanged. The value of Mexican peso will increase and thus there will be appreciation in the exchange rate. The imported goods will become cheaper (Ma, 2015).

Reference list

Argy, V. E., & Nevile, J. (Eds.). (2016). Inflation and Unemployment: Theory, Experience and Policy Making. Routledge.

Baumol, William J., & Alan S. Blinder. Microeconomics: Principles and policy. Cengage Learning, (2015).

Bekaert, G., Hoerova, M., & Duca, M. L. (2013). Risk, uncertainty and monetary policy. Journal of Monetary Economics, 60(7), 771-788.

Bordo, M. D., & Landon-Lane, J. (2013). Does expansionary monetary policy cause asset price booms; some historical and empirical evidence (No. w19585). National Bureau of Economic Research.

Canada Inflation Rate | 1915-2017 | Data | Chart | Calendar | Forecast. (2017). Tradingeconomics.com. Retrieved 29 August 2017, from

Cochrane, J. H. (2016, April). The Fiscal Theory of the Price Level and its Implications for Current Policy in the United States and Europe. In Next Steps for the Fiscal Theory of the Price Level” conference at the Becker Friedman Institute for Research on Economics at the University of Chicago (Vol. 1).

Ekelund Jr, R.B. & H?bert, R.F. (2013). A history of economic theory and method. Waveland Press.

GDP growth (annual %) | Data. (2017). Data.worldbank.org. Retrieved 29 August 2017, from

Hall, Robert E., & Marc Lieberman. Microeconomics: Principles and applications. Cengage Learning, (2012).

Hommes, C., Massaro, D., & Salle, I. (2015). Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence from the Lab. CeNDEF working paper, (15-11).

Ma, C. F. (2015). An Insight on the Rationale of Using Expansionary Monetary Policy during the Great Recession. University of Toronto Economic Review, 58.

Mankiw, N. G. (2014). Essentials of economics. Cengage learning.

Ryan-Collins, J. (2015). Is monetary financing inflationary? A case study of the Canadian economy, 1935-75.

Sims, C. A. (2016, August). Fiscal policy, monetary policy and central bank independence. In Kansas Citi Fed Jackson Hole Conference.

Svensson, L. E. (2015). The possible unemployment cost of average inflation below a credible target. American Economic Journal: Macroeconomics, 7(1), 258-296.

Wetzstein, M.E. (2013). Microeconomic theory: concepts and connections. Routledge.

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