Policy Brief on effects of investment to the governor and staff of the Bank of Canada

Policy Brief on effects of investment to the governor and staff of the Bank of Canada

Introduction

In order to stir or slow down economic growth, the Bank of Canada manipulates the interest rates, by either increasing or lowering it, therefore, curtailing investment or encouraging investment in the process. However, there have been growing debate whether interest rates manipulation by the Bank of Canada affects investment in the country. According to an analysis by the Economist, although interest rates movements play some role in the investment of firms in the economy, factors such as profitability and value of shares play a much bigger role than interest rates[1]. Therefore, government measures such as tax rates and regulation affect investment of firms more than interest rates due to their direct impact on the firm’s profitability and value of shares. This policy brief will provide a comprehensive analysis of the effects of investment to the governor and staff of the Bank of Canada by focusing on the effects of demand shocks and the level of monetary policy aggressiveness.

Monetary Policy Implications

Short-term output affected by demand shocks are bound to be derailed as a result of inefficient monetary policy to mitigate the demand shock. Aggregate demand will increase or decrease according to the nature of the demand shock because interest rates will have minimal impact on investment of firms. An analysis reveals that despite the minimal impact of interest rates on investment, firms tend to invest more when profits surge and reduce investment when bad news takes effect[2]. Therefore, increasing or decreasing interest rates during the demand shock will not derail investment because firms, in this case, are bound to maximize profits as a result of changing prices while the supply of the output remains inelastic.

If the firm producing the output is making a profit during the demand shock, the monetary policy of increasing or lowering interest rates to influence investment in the output will be insufficient. The ability of the firm to make a profit out of the short-term output indicates that the demand shock is positive, and the aggregate demand is increasing. Based on the analysis of the article, factors such as the profitability of the firm and how well its shares are doing are far more important in mitigating a firm’s investment than interest rates[3]. Therefore, the Bank of Canada needs to consider employing measures such as taxation and regulations to mitigate against the effects of demand shocks on short-term output.

In determining the appropriate level of aggressiveness of Central Bank’s monetary policy, the level of uncertainty or indeterminacy plays needs to be considered. According to a study by Thoma, the level of uncertainty or indeterminancy arises when the inflation is less than one[4]. Therefore, when indeterminacy arises, the Central Bank is expected to employ highly aggressive monetary policy to avoid a potential economic crisis, thus bringing the inflation down in the process. However, based on the findings of the Economist’s article, interest rates is merely a significant measure to curbing investment level that eventually controls the economic growth or stagnation of a country. Consequently, the application of interest rates in order to control the investment of levels in the country’s economy demonstrates that the level of aggressiveness of Central Bank’s monetary policy is inefficient. Therefore, whenever inflation rates increases, interest rates will not be a sufficient aggressive monetary policy response as compared to adjusting taxes or increasing regulation.

Conclusion

Manipulating interest rates as monetary policy to influence the level of investment in the country is not a sufficient policy method that the Bank of Canada can employ to control the economy. Although the interest rates have some impact in influencing some aspect of the investment level of a firm, it is less effective in curbing effects of demand shocks on short term output as well as the least aggressive response of the Bank of Canada to curb issues such as rising inflation rates.

References

The Economist. 2014. Tight, loose, irrelevant. 18 October. Accessed March 2, 2020. http://www.economist.com/news/finance-and-economics/21625875-interestrates-do-not-seem-affect-investment-economists-assume-tight-loose.

Thoma, Mark. 2007. Changes in the Aggressiveness of Monetary Policy Toward Inflation. 16 July. Accessed March 2, 2020. https://economistsview.typepad.com/economistsview/2007/07/changes-in-the-.html.

[1] The Economist. 2014. Tight, loose, irrelevant. 18 October. Accessed March 2, 2020. http://www.economist.com/news/finance-and-economics/21625875-interestrates-do-not-seem-affect-investment-economists-assume-tight-loose.

[2] The Economist. 2014. Tight, loose, irrelevant. 18 October. Accessed March 2, 2020. http://www.economist.com/news/finance-and-economics/21625875-interestrates-do-not-seem-affect-investment-economists-assume-tight-loose.

[3] The Economist. 2014. Tight, loose, irrelevant. 18 October. Accessed March 2, 2020. http://www.economist.com/news/finance-and-economics/21625875-interestrates-do-not-seem-affect-investment-economists-assume-tight-loose.

[4] Thoma, Mark. 2007. Changes in the Aggressiveness of Monetary Policy Toward Inflation. 16 July. Accessed March 2, 2020. https://economistsview.typepad.com/economistsview/2007/07/changes-in-the-.html.