Hi everyone and welcome to chapter 3. In this long recording we are going to discuss about different economic principles and let's start. So what is economics? Economics is understanding the choices that people people make who are people so it can be individuals companies or governments and how all those choices sum total of all those choices impact the economy okay a market economy describes all activities related to producing and consuming goods and services and how decisions of people firms and government determine the proper allocation of resources so it is like you the provincial government the federal government and all the companies whenever they take decisions on what to buy what to sell all that becomes part of the economy scarcity prevents us from having as much as we would like for certain goods and services so goods are not infinite neither are services so example would be oil there is not infinite oil in the world right there is a limited amount of supply for oil so you prices are determined by the total supply that is coming in and total demand for that product. Ultimately, the interaction between market participants determines what we pay for the good, service, share or mutual funds.
So it is all economics is basically demand and supply. So how much demand is there for the product, right? It can be a stock, it can be some good like oil, it can be a service like education so if the demand is lot but there is limited supply price goes up but if the demand is small and the supply is coming up supply is expanding then the price goes down so it is an interaction between demand and supply Now there are two streams of economics micro and macro. So we'll discuss in brief both of them.
So microeconomic it microeconomics it analyzes the market behavior of consumers, households, and producers with the supply with the focus on supply, demand and prices. So it generally analyzes entities. So it analyzes consumers like individuals it analyzes companies and government so it analyzes entities participants in an economy microeconomics tries to answer a question such as how do minimum wage laws affect the supply of labor and company's profit margin. Now, if you think about it, right, minimum wage laws.
So, example would be, let's say Joe Biden is considering to have a $15 minimum wage all across United States. Now, how will that impact? So, if people get $15, right, so the consumers purchasing power increases, right, so that would increase the demand.
Right on the supply side, when wages goes up, the cost for companies goes up because they have to pay more for employing those employees. So profits goes down. So it's an interaction between how it will impact demand because more people are earning better.
And how would it impact? supply right because if prices go up like if cost go up prices go up so that would impact supply too so it's a complex dynamic so a simple decision like raising minimum wage has widespread implications how would tax on soft lumber imports going into united states affect the growth potential of forest industry example will be an exports from canada to example would be we produce a lot of aluminium and under trump so aluminium from united states was being taxed because he put a lot of tariffs on products from united states so when tariffs are put on Goods that Canada exports the demand for those goods go down. That's why the industry was negatively impacted if a government placed a tax on purchase of mutual funds Consumers may not may stop buying example in in Canada right now, let's let's Consider capital gain tax. What is capital gain tax when whatever gain you are making on assets, right out of that 50% is taxed.
That's the current law. What does that mean? If I'm buying some stock in a non registered account, so it's not TFSA or it's not RRSP. So it doesn't have any tax benefits, but it's a non-registered account. So if I buy a stock at $100 and sell it at $200, I'm making a $100 gain.
Out of that $100, only 50% is taxed at my tax rate. Okay, so $50 would be taxed, I'll pay taxes on $50 and whatever is my tax rate. Okay, but now if they change that law to 75% of capital gain, then the taxes would go go up and mark means individual participants may not buy stocks or mutual funds because they may not like the taxes that are coming in.
So all these things are microeconomics. Then what is macro macro is the umbrella it's like overall big decisions. So focus on performance of economy as a whole and includes major decisions like unemployment, inflation, recessions, government spending, taxation. poverty and inequality, budget deficits and surpluses, national debt. So micro is looking at participants separately.
So looking at what decisions the consumers are making, what decisions the companies are making, right? And macro is looking at it from a broad angle, from a bigger angle. Okay, macroeconomics looks to answer questions like why did the output shrink last quarter? So in pandemic, the output has been shrinking.
Why has it been shrinking? Because people are at home, they are not going out and buying a lot of stuff, they are saving their money. So saving rates have gone up, the demand for products has fallen. And because of that the gross domestic output, the GDP has fallen. Why have the number of jobs fallen in the last year?
That could be a question that could be answered by macroeconomics. Will a decrease in interest rates stimulate the economic growth? When you decrease interest rates, people tend to borrow more.
So companies borrow more, consumers borrow more, governments borrow more. So if borrowing happens, some of that borrowing gets converted into spending. That's why lower interest rates generally Boost the output, boost the economy.
How can a nation improve its standard of living? So all these questions are given by answered by macroeconomics. Now who are the economic decision makers?
So there are three primary groups of decision makers that interact with the economy. It is consumers, consumers, which are out to maximize their satisfaction or well-being with limitations of available resources so consumers are entities who buy now consumers don't necessarily mean that they are individuals sometimes individuals buy companies buy as well as government buy stuff right so consumers can be all three it can be businesses out to maximize their profits that's the number the whole idea of for-profit business is to make profit so companies are run by companies are run for the benefit of shareholders so shareholders objective is to increase profits and governments governments are entities that must spend money on education health care employment training military which includes typically building of bridges, roads, schools and services. So what do governments do? Governments provides the necessary infrastructure for consumers and business to operate.
So they have some responsibilities like providing safe environment through defense and police and all of that. They have some responsibility to create the basic infrastructure, roads, schools, colleges and all of that. and they also have responsibility of building basic infrastructure for companies like the taxation system, the regulatory system and all of that. Next, demand and supply. So, market equilibrium means the price of a good.
So, price of a good depends on whatever demand is there and whatever supply is there. So, prices are generally an interaction between demand and supply because as the price grows the demand will fall if the goods become expensive the demand will fall but what would happen to supply supply will actually increase because more producers will get into those goods so demand Demand and supply interaction of that gives you market price. So market equilibrium occurs when price that consumers are willing to pay matches the price at which suppliers will sell. There are two general economic principles that helps to explain the interaction of supply and demand. The quantity demanded for goods and service is the total amount that the consumers are willing to buy at a particular.
price at a particular time. The law of demand states the higher the price, the lower the quantity demanded. The quantity supplied for a good is the total amount that the producers are willing to supply at a particular price.
The law of supply states that the higher the price, the quantity supplied will increase. So basic thing that you have to remember law of demand as the price goes up, the demand falls. Law of supply as the price increases, the supply increases.
because it is more profitable for companies to produce that good so they will get into it next measuring the national economy measuring the national economy involves tracking the gross domestic product of a country now gross domestic product is the market value in current dollars of all financial goods and services that are produced within a country in a particular year so generally what we do we Try to calculate all the value of goods and services that are produced in our financial year for a specific country. There are two approaches used to calculate the gross domestic product. The expenditure approach, which means try to calculate how much people are spending to buy goods and services.
Or the income approach, it is try and calculate the income that suppliers are receiving for those goods and services. Regardless of which approach you use, the gross domestic product that you calculate should be same. The income approach totals the income that the firms pay household for practice of production that they hire or rent, such as wages, rents, interest and profits. So income approach looks at accumulation addition of total wages that the companies pay or governments pay.
whoever is the producer pays total amount of rent that they pay total amount of interest expense and total profits that are made by entrepreneurs and corporations the expenditure approach which is the more followed one so most gross domestic products across the world are looked at using the expenditure approach okay except maybe China, China calculates more, China is not a consumer, China was not a consumer driven society till now. So it was focusing on the income approach to estimate such gross domestic product. That is why it was producing more and more goods so that the GDP goes up. But most developed countries right follow the expenditure approach in which we calculate personal consumption, the total consumption that is done.
by individuals, the investments that are going in, government spending that is happening and exports minus import that is the net exports the country is producing. So gross domestic product for Canada will be total consumption in the country plus total investments in the country plus the government spending that is happening plus X minus M that is total exports that are taking place. Now if you just Google it.
just open let's check out gross domestic product for Canada So gross domestic product is somewhere around 1.7 trillion right 1.7 trillion it is expected to be 1.7 trillion in 20 in 22 it is 1.6 almost 1.6 trillion by 2020 so what does that mean that in a given year Canada produces and goods and services produces or consumes goods and services worth 1.6 trillion dollars right now which is composed of how is it calculated it is calculated using personal consumption it is used calculated using investments government spending and net exports so if you add all of them up it will come down to 1.5, 1.6 trillion. Okay. Now, there is a real difference between nominal GDP and real GDP.
So what is nominal GDP? Nominal GDP does not account for inflation. So GDP eventually will keep on increasing because goods and producers get costly every year.
So the growth in GDP Right? Accounts for inflation is called the real GDP. So I'll explain it on an excel sheet. So let's first read it and then we'll go to excel sheet. The nominal GDP is the dollar value of goods and services produced in the given year that prevailed in the year and typically is the amount that is reported in financial press or media.
The real GDP or constant GDP is the goods. That is the dollar value of all goods and services that are produced in a given year valued at prices that prevailed in some base year. So what does that mean?
So basically it means that nominal GDP equals to real GDP, real gross domestic product plus inflation. So nominal GDP equals to real GDP plus inflation or other way to look at it real GDP equals to nominal GDP nominal gross domestic product minus inflation. Okay, so what is the real GDP real GDP is real growth in the economy that is growth due to productivity increase growth due to labor force increase growth due to Consumer base increasing the real growth now Now real growth is given by whatever nominal growth you got minus the inflation in what is inflation inflation is increase in prices. So every year price things become more expensive right because it is more costly wages go up everything goes up. That's why every year products become more expensive that expensiveness is captured by inflation.
So real GDP is nominal GDP minus inflation. So productivity and determinants of economic growth. Now how do you increase this gross domestic product?
Gross domestic product we saw it was 1.6 trillion by 2022 it is expected to be 1.7 trillion. So how is that increase happening? So increase happens the growth in GDP results from variety of factors increase in population over time. So as the population of the country grows up the consumer base goes up. So see consumption goes up.
That's why the GDP goes up increase in capital stock that is machinery and processes. That is the I part investment part. So if businesses are making more investments right every in the coming year like in the given year.
So that's the I part investment part. then GDP goes up. It also improves, it also goes up because of improvement in technology, right?
So it is L, labor, C, capital and T, tech. Long term growth of any gross domestic product, any country's GDP is given by the increase in labor, right? Increase in earning members, then increase in capital stock and increase in technology.
Improvement in Technology Now, GDP doesn't move in a straight line. So we want it to move in a straight line, but it goes through cycles. So there are phases when GDP expands a lot that's called as expansion.
There are phases when it appears to get a peak and then it goes down through a recession, it bottoms out, then the recovery starts, then it expands again. So it generally goes through cycles. Now why do these cycles happen?
These cycles generally happen because of monetary policy. Monetary policy means during expansion the interest rates start going down, people get more money in their pockets. The fiscal policy is expansionary, it means government is spending more and more. Because of that expansion happens. So unemployment starts dropping, people get more income, they spend more.
the consumption happens inventories for company drop because people are buying all those inventories okay so in expansion wages go up the economy expands consumption go up everything is good then we achieve a peak and then the fall happens why do we achieve the peak maybe because the government spending has gone up a lot so there is not much scope of increasing it there you then interest rates are very low so you can't reduce it further and inflation is kicking in right during expansion inflation also increases Because of inflation, things are becoming expensive. So people's per capita consumption is starting to show a fall. So after peak, the recession happens.
In recession, unemployment increases. People don't have jobs. They get fired. The total unemployment in the economy increases. Then the economy shrinks, economic contracts.
It doesn't grow as much. and interest rates start to drop again during expansion slowly the interest rates have peaked but during peak time during recession time to stop this recession monetary policy generally is expansionary so interest rates start dropping then we achieve a bottom and the cycle repeats so economy doesn't move in straight lines it moves in cycle expansion happens right During expansion interest rates in initial phases of expansion interest rates have dropped, economy is expanding, people are spending more, we achieve a peak, then it drops again. Now how do we know whether the economy is expanding or contracting? So we generally look at economic indicators. So these are statistics that are used to analyze business conditions and economic activity to predict turning points in an economy to determine if economy is expanding or contracting.
There are three types of indicators. There are some indicators called leading indicators. So they generally happen before the economy starts showing those signs.
Coincident indicators, they happen along with the economy and lagging indicators, they happen after the fact of expansion or contraction starting. So what are leading indicators? Housing stats.
So people buying housing inventories, dropping people, buying more. houses like so house construction starts to go up so that is housing stats housing stats is number of houses being constructed then stock market is always a leading indicator it's not backward looking so even if economy is in trouble stock markets may start to pick up why would they pick up because they are seeing forward they are forward looking so they are seeing six months one year down the road the economy is coming back that's why the markets pick up you Commodity prices, especially copper. Copper is a commodity with a PHD.
So copper prices generally lead, like generally they happen, prices go up before the economy goes up. So copper is a good indicator for that. They peak and trough before the main economy peaks and troughs. So before it rises or falls, these indicators change before that.
Coincident indicators are GDP numbers. Personal income, industrial production, retail sales, unemployment, that is payrolls, right? They point to what is happening in the economy right now. Now, there are some lagging indicators too. Lagging indicators are unemployment numbers.
So, payrolls and unemployment is different. Payrolls means number of people getting hired, so jobs that are coming in. Unemployment means number of people who have jobs. So there is a subtle difference between the two. Inventories are a lagging indicator.
Labor cost, business loans, interest such as borrowing, private sector spending on plant and all. All of these are lagging indicators. They measure what has been taking place and change after the economy as a whole has changed. So to predict recessions and predict like expansions, we generally look at. leading indicators.
So housing stats, stock markets, money supply and commodity prices, even money supply, right? Money supply generally starts to expand. That's why the expansion in the economy happens.
Now, if you look at it this year in 2020, money supply has expanded a lot. Lot of countries around the world are printing insane amount of money. So In like in United States around money supply is up over around 20%. So money supply has changed by 20%.
So that generally leads to an expansion. Now what is recession identifying recessions? A popular definition of recession is two consecutive quarters of declining growth.
So whenever you get back to back declining growth in GDP, that is technically called as a recession. Stats Canada judges a recession by the depth, duration and diffusion of the decline used. Using criteria, the decline must be of substantial depth since marginal decline could be a result of a statistical error. The duration must be more than a couple of months since bad winter alone can cause temporary decline in output.
The decline must be a feature of whole economy since strike in a certain part of the economy can cause GDP to decline. The behaviour of employment and per capita income needs to be taken into account. Now, Labor market indicators are important. There are two key indicators that describe the labor market. What is labor market?
The working age population. How are they interacting with the economy and with each other? The participation rate. This represents the share of working age population that is in the workforce.
Important because it shows the willingness of people to enter the workforce and take job. So participation rate means the number of people who are actively looking for work. work. Now sometimes the economy is so bad that number of people actively looking for work actually goes down.
So unemployment may fall but it doesn't mean that the economy is doing well. It may be because the participation rate has gone down. The unemployment rate represents the share of working force that is employed and actively looking for work. Types of unemployment, it can be cyclical, it is tied to the fluctuations in business cycle, rises when the economy weakens and drops when it strengthens. So some part of employment is cyclical.
Businesses are doing well, they hire more people, so the employment shrinks. But if business is going to recession, they try to remove people. That's why the unemployment base increases.
It can be frictional. The result of normal. labor turnover with people being in between a former job they previously had and one they're about to start.
So some part of unemployment is because of frictional because it is frictional in nature. Maybe you quit a job you're taking few months break and then starting again in some job. So in that case that will be frictional.
It can be structural and this is a big problem when workers are unable to find work because they lack the necessary skills. scales or they do not live where the jobs available are or they decide not to work at the wage rate that is being offered by the market often requiring that the market that the workers receive retraining or reallocation to find a job. So what does that mean is economy is changing around us there is a lot of tech being used so a lot of jobs are changing I am not saying that they are going away jobs more or less are remaining the number of jobs more or less are remaining stable but jobs are changing so for that change to happen the workers need to be rescaled so that rescaling may take time so that structural unemployment is captured here next is seasonal some industries operate only during certain times of the year and lay off employees when the season changes example people lot of people work in the Christmas industry so there are people who use like decorates put up christmas lights and all of that so that employment is generally only for limited duration so that's called as a seasonal employment or maybe you're a ski instructor so skin instructors can generally work only in winters you cannot work in summers so that creates a problem the role of interest rates Interest rates are important link between current and future economic activity.
They're essentially the cost of credit and compensation for saving and reflects the demand and supply of credit and debt. The changes in interest rates by Bank of Canada signal changes in direction of monetary policy, which has broad implications for entire economy. So generally what happens when the country wants to boost its economy? it will reduce the interest rates so that people borrow more, right?
But when people borrow more, inflation kicks in. So things start becoming expensive. When inflation goes little bit out of bond, they start to raise the interest rates. So it's a flow. When economy is doing bad, generally interest rates go down.
They depress the interest rates so that people borrow more. When people borrow more, they spend more. which because of which the inflation kicks in. And when inflation starts going up, they raise the interest rates to counter that. Determinants of interest rates.
There are five broad factors that influence the interest rate. Demand and supply of capital. So that will determine the interest rates. If a lot of capital is coming into your country, then there is a lot of demand.
Right. That may lead to changes in interest rate, default risk and associated default premium. So if country is becoming more risky to do business with, right, to invest in, then.
the interest rates in that particular country generally go up to compensate investors for that additional risk an example that comes to my mind is lebanon so lebanese interest rates have been going up the reason they are going up is because lebanon is in an economic turmoil so investing in lebanon has becoming more risky so to compensate for that they have increased the interest rates foreign interest rates and exchange rates so if you want to increase the increase what strengthen your own currency you generally increase the interest rate if you want to weaken your own currency you generally decrease the interest rates okay so let's say china china wants to strengthen its currency so it will try to increase the interest rates if it wants to weaken its currency it will decrease the interest rates now why does it matter when you increase the interest rate capital from outside flows into the country why because people are looking for yields they are looking for interest so if a country is giving more interest capital will flow there that's why currency depends more or less on interest rates center bank creditability so keeping interest rates low and stable and controlling inflation is the objective of center banks central banks. So that is how the interest rates are determined and inflation is the major component. When inflation is rampant, the interest rates are increased to control that inflation. Now, how interest rates affect the economy? Higher interest rates affect the economy in these ways.
Raise the cost of capital for doing business, make it more difficult for companies to make profit from investing in itself, thus reducing the business investment in itself. So, when you raise interest rate, companies that have borrowed, right, they will have to spend more on interest payments. Because of that, their profits will go down. It also discourages consumers from spending especially if they will need to borrow money to buy expensive assets such as houses, cars and discourage business that needs to borrow to expand. Specific impact of this has been seen all across the world but specifically in Canada.
Canadian housing market in 2020 is super hot. Why it is super hot? Because interest rates are near zero.
So a lot of people are borrowing more and more money to buy those houses. That's why the housing prices have gone substantially up in 2020, even during a recession. That's because of interest rates. High interest rates leave less money available to consumers if they have large loan payments on assets they borrowed money for in order to buy them, thus leaving with less money to spend on other things. So when interest rates go down, you have more disposable income because your debt costs less if interest rates go up.
So imagine the people who are borrowing right now. for houses so if the interest rate shoot up like 100 basis point or 200 basis point that is 1 or 2 the disposable income will fall substantially because they have to pay more towards their housing debt in that case what would happen their disposable income goes down their spending also goes down okay The nature of money, money can be an object that is accepted as payment for goods and services and that can be also used to settle debts. Money has three major functions.
It's a medium of exchange, it is a unit of account and it is a store of value. So money is something that you use for trade purposes to buy and sell stuff inflation inflation is a sustained trend of rising prices so things becoming expensive is inflation Example would be, let's say you're buying Tim Hortons coffee in 2019. Tim Hortons normal drip coffee is costing you 2 bucks. Now in 2020, it is costing you 3 bucks. So it has gone up. How much it has gone up?
up around 50%. So that is nothing but inflation. It is measured by Consumer Price Index, CPI, published by Statistics Canada that tracks retail shopping basket of 600 different goods and services, each weighted to reflect typical consumer spending. What does inflation do? Inflation erodes the standard of living for those on fixed income and those who lack wage bargaining powers.
So inflation specifically hurts blue-collared labor. because their wages generally don't adjust for inflation. We haven't had wage growth in North America.
Inflation adjusted wage growth in North America. for decades for blue-collar workers in last five years and since 2015 we did get some growth but that's about it the real wage growth in blue-collar worker in north america wasn't there right so inflation eats away at their money it also eats away at people who have fixed income fixed income means people who are pensioners their income doesn't change they are drawing from their savings to feed themselves and to live So inflation generally impacts these people a lot. It reduces the real value of investment because lenders will increase the interest rates they charge on loans when the rate of inflation rises.
It also distorts prices. So what does it do? It reduces real value of investment. So whatever investments you are making, if they are not growing, at least by the rate of inflation, then you're losing money. For example, if I put my money in a bank deposit right now, maybe the inflation is 2%, but bank deposits are getting me 0.5%.
So, in that case, I am losing money because my money is not growing by inflation. It distorts prices. So, it is very damaging to prices.
Rising inflation causes rising interest rates and usually a recession follows. Economist. use an indicator called the output gap to major inflation pressure in the economy by looking at difference between real GDP what the economy actually is producing and the potential GDP what the economy is capable of producing when labor capital and tech are fully used at the normal level potential output is the maximum level of real GDP that the economy can maintain without inflation rising so what does this mean mean is it's a very narrow thread that the central banks works on.
In one aspect, they want to increase the gross domestic product by expanding the economy. But the moment you have expansionary monetary and fiscal policy, inflation kicks in. So inflation causes recession.
So they want to control inflation too. So it's some fine balance between expanding the economy and controlling the inflation. Causes of inflation, a negative output gap occurs when actual output is below the potential output. So what does it cause it? There is scarce capacity in the economy.
Inflation will fall or remain steady. So If there is lot of spare capacity in the economy, lot of suppliers have inventory that is unsold. During that case, inflation will generally fall or remain steady. The potential for contraction of the economy is real. Output gap occurs when actual output is above the potential output.
The economy is operating above capacity. Scarce labor causes wages to rise. Other strains on the economy increase cost causing inflation to rise because higher consumer demand also known as demand pull inflation.
So there is supply side inflation and demand side inflation. So I'll explain giving examples. So why has inflation not kicked in substantially in North America? It's because. because of China's supply chains.
So China was producing goods at a very low cost and then giving it to North America because of that inflation has remained low. But now you have a negative feeling towards China in general. I'm not saying because of trade wars and all of that, right? And even in China, the wages are increasing.
So no longer it is the low cost provider. So what will happen because of that the supply side is getting expensive it is getting more expensive to get good from china so that would result in inflation now there is demand side inflation too now during 2020 because of pandemic most people are staying at home they have excess savings because they are not spending in a usual way that they do maybe you are spending more than what you usually really do but on an average the spending has gone down the saving rates are up so there is lot of pent-up demand in the economy so when the economy opens up and everything is normal this pent-up demand will flow into goods and services so there would there is a demand side dynamics to inflation and there is a supply side dynamics to inflation now this is a concept that is quite dangerous it is called as disflation Disinflation is decline in the rate at which prices are rising. Prices are still rising but they are at a slower rate. Deflation is often confused with disinflation.
So deflation is different, disinflation is different. Disinflation means that the prices are rising but the rate of growth, the rate of increase in prices has slowed down. Deflation means deflation is really bad.
Deflation means things are becoming less and less expensive. It is a sustained fall in prices where the annual change in CPI is negative year after year. Deflation is therefore opposite of inflation.
You can see there are a lot of deflationary economies. So European Union, some countries are deflationary. Japan has been deflationary for quite some time. So things are becoming less expensive every year.
Monetary policy. regulation of money supply and available credit for the purpose of producing sustained goods so what is monetary policy monetary policy is a policy that is conducted by the central bank in Canada it is done by Bank of Canada in US it is done by Federal Reserve in Japan it is done by Bank of Japan okay so central bank it's not the ruling government it's a central bank who decides the monetary policy now central banks are supposed to be independent from the ruling government okay now what do central banks monetary policy does central banks monetary policy decides the money supply there there they have two objectives one sustained economic growth second control inflation so both of them are opposed if you increase your economy a lot inflation kicks in but if you control inflation the economy starts to slow down so they have a team they have a balancing act where they try to induce growth at sustained level or reasonable levels of inflation. So their goal is to maintain the value of currency and the economy as total. The Bank of Canada is responsible for money supply by regulating credit and currency, controlling and protecting the external value of monetary units.
So they try to maintain value of Canadian dollars. If you print a lot of Canadian dollars and other countries are not printing, then the value of Canadian dollars falls. It mitigates fluctuation in production, trade, price.
prices and rate of employment. It promotes economic and financial well-being of Canadians. There are two types of monetary policy expansionary increase the amount of money and credit available in the economy.
So increase the money supply and increase the credit. Now, how does central bank increase the money supply? They money is created by banks of the country right when they give out credit.
So they can induce banks to give out credit. out more credit or they can directly lend to like it is being done right now they can directly lend to business as well as consumers in that case you're creating more money okay if the bank of canada lowers the overnight rate and the bank rate interest rates at the bank will drop if the bank of canada buys bond in the market the money supply will increase monet bank of canada doesn't have spending has lending powers so it can buy and sell bonds to induce money or it can change the interest rates to do that but it cannot directly spend it cannot directly spend money on creating a role that is the job of government. If Bank of Canada raises the overnight and bank rate interest rates at the bank will rise.
If Bank of Canada sells the bond, the money will shrink. That is having a contracting a monetary policy where you decrease the amount of money and credit available in the economy the Bank of Canada manages short-term interest rates in Canada by setting two key interest rates the overnight rate which is the rate the major Canadian financial institutions will lend each other on overnight basis overnight borrowing rate is what banks lend and give to each other okay for example RBC to maintain its reserve requirements may borrow from TD for a day that is the overnight lending rate the bank rate is the interest rate that bank of Canada will lend money on a short-term basis directly to the banks and to the members of Canadian Banking Association as a Bank of Canada's role to be lenders of last resort. Drawdown and redeposits are another set of monetary policy.
A drawdown refers to transfer of deposits to Bank of Canada from banks, draining money from the economy and reducing the money available to the bank. give to clients putting upward pressure on interest rates or re-deposits refers to transfer of deposit from bank of canada to the banks increasing the money supply and the amount the amount of deposits the bank have to lend it to your to its customers putting a downward pressure on interest rates and get so that was monetary policy then comes fiscal policy so monetary policy done by central banks fiscal policy is done by the ruling government so ruling government in our case is the Liberal Party so the party in power generally comes out with the fiscal policy fiscal policies mostly concerned with taxation and spending by the government. It is a deliberate action by the government, federal, provincial and territorial to influence the economy through changes in either spending or taxation.
Expansionary policy involves moving to stimulate the economy by increasing the spending activity or decreasing taxes or doing both. Contractionary policy involves attempting to slow down or cool off an economy by raising interest rates. by cutting the spending or increasing taxes.
Fiscal policy affects the economy in two ways. Spending to purchase goods and services such as contracts to build bridges, roads, schools, hospitals will boost the economic activity. when the construction companies have to purchase equipment, supplies and hire people to do work.
Taxes charged to the business and people on salaries, profit, purchase in stores and owning property will generate the money that the government needs in order to spend on these projects. Governments will increase spending and lower taxes in order to stimulate the economy and then reduce spending and raise taxes to slow down the economy. So how does government stimulate or increase the economy, it will try to spend more.
So a lot of capital projects like building bridges, building metros and all of that, or and it will tax less. Okay, if it wants to slow down the economy, it will reduce its spending and increase the taxes. International economics. This deals with interaction that Canada has with the rest of world in terms of trade, investment, capital flows and exchange rate.
Canada's dependence on export is extremely important because at least 30% of our GDP. Last time I checked. it was somewhere around 34% to be exact is because of exports.
So Canada is a natural resources exporting country. One third of our GDP comes from that. Now that will be mining, agriculture, it can be oil and gas and all that stuff.
Canada's international trade is expressed in what is called as balance of payments through two important accounts, the current account and capital account. So current account captures the trade transaction, capital account captures the investment transactions. So if people are investing in Canada, it will be inflow into the capital account.
If people are investing out of Canada, that will be an outflow. Same way if exports are increasing. Trade balance improves if exports fall the trade balance the current account falls. If we buy more goods and services import from abroad then we sell exports we have a balance of payment deficits. So if we import more then our trade balance falls and we have a deficit.
If we sell more than we buy we have a balance of payment surplus. The current account, the most important component of a trade, the goods and services we produce and sell abroad and those we buy from other countries get captured in current account. Strong foreign demand for our products and services will lead to more exports, which is helped when the value of our dollar fall against foreign currency, mostly US dollar.
Most of our trade goes to United States. United States is Canada's largest trading partner. and for United States we are the third largest trading partner for them so most of our trade happens between most of the trade that happens in Canada it happens between US okay so we either import from them or we export to them The capital and financial accounts reflects the acquisition of assets and right to income that it earns such as when a foreign investors buy a Canadian company and benefits from sales made by that company.
So that's it in this module. See you in the next one.