During the financial crisis of 2007-2008, the Bank of Canada took extraordinary

Question

During the financial crisis of 2007-2008, the Bank of Canada took extraordinary actions to inject liquidity into the banking system. As a result, the amount of reserves in the banking system increased significantly.

A)   Why might the Bank choose to increase reserves in the bank system in such an economic environment?

B)   Despite the large increase in reserves, there was not a large increase in the Canadian money supply. Can you provide an explanation?

C)   Given your answer to part (b), would you predict that the Bank

Explanation / Answer

a

When the Investors Sentiments are low as was the time during the financial crisis of 2007-2008 ,injecting money into the economy will help revive investment again because increasing money supply helps to provide the capital at a cheaper rate for the investors thus the investors will have a higher opportunity cost for not investing.

b

The monet supply was low because investors were very skeptical to invest money in their hand.Thus though there was easy money in the economy, the money supply and velocity didn't change.

c

Yes bank's action may lead to more inflation because printing more money out of thin air may provide a boost to the economy at first but in long run it will surely lead to higher inflation as their will be more money in the hand of people to spend.

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