Expansionary monetary policy on the part of the central bank of Canada will cause:
A. an increase in interest rates in Canada and an increase in the value of the Canadian dollar relative to other currencies.
B. a decrease in interest rates in Canada and an increase in the value of the Canadian dollar relative to other currencies.
C. an increase in interest rates in Canada and a decrease in the value of the Canadian dollar relative to other currencies.
D. a decrease in interest rates in Canada and a decrease in the value of the Canadian dollar relative to other currencies.
The correct answer and explanation is:
Correct Answer: D. a decrease in interest rates in Canada and a decrease in the value of the Canadian dollar relative to other currencies.
Explanation (300 words):
Expansionary monetary policy is a strategy used by a country’s central bank—in this case, the Bank of Canada—to stimulate economic growth, especially during periods of slow economic activity or recession. The central bank implements this policy primarily by lowering interest rates or increasing the money supply through mechanisms like purchasing government securities.
When the Bank of Canada reduces its policy interest rate, it becomes cheaper for consumers and businesses to borrow money, encouraging spending and investment. Lower interest rates also reduce the incentive to save, which further supports higher consumption and economic activity. As more money circulates in the economy, aggregate demand increases, which can help close an output gap and reduce unemployment.
However, lower interest rates have international consequences. Investors generally seek the highest return on their investments, often moving capital across borders. When interest rates fall in Canada, Canadian financial assets become less attractive to foreign investors compared to countries offering higher interest rates. As a result, there is less demand for the Canadian dollar in foreign exchange markets.
Reduced demand for the Canadian dollar causes its value to depreciate relative to other currencies. A weaker Canadian dollar can make Canadian exports more competitive abroad (since they’re cheaper in foreign currencies), which can also help stimulate the economy.
In summary:
- Interest rates go down → borrowing and spending go up.
- Value of the Canadian dollar goes down → exports become more attractive.
This makes option D the most accurate description of the effects of expansionary monetary policy in Canada:
“A decrease in interest rates in Canada and a decrease in the value of the Canadian dollar relative to other currencies.”