In order to support the Canadian dollar, suppose the Bank of Canada buys an amount of Euros from some major commercial Canadian banks (a type of operation the Bank of Canada rarely undertakes).

Question

Describe what limits the precision of the Bank of Canada's control of the money supply and explain how it limit that control.

The immediate impact of this operation is that there will be an increase in money supply in the economy as a result the exchange rate will decrease and the currency will appreciate. In the long term as the domestic currency appreciates the demand for export falls and demand for import rises as exports become expensive and imports become cheaper and the domestic currency will depreciate as demand for foreign exchange increases.

When Bank of Canada buys Euros from cmmercial banks, then it will have to sell Canadian dollars to these commercial banks and selling of the domestic currency to the bankS would increase the level of money supply in the economy. Thus, both immediate and long term impact of this operation on the level of money supply is to increase the level of money supply in the economy.