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As we have seen, the 8 to 10 – percent annual inflation rates of the period since the early 1970′s have been dramatically higher than the inflation rates of 2 to 5 – percent characteristic of the 1950′s and 1960′s. Such rapid inflation rates have caused great concern among the public, as well as considerable confusion as to their causes. Generally, it is reasonable to say, that the real causes of this severe inflation were quite different from what the public believed to be its causes.

While the period since the early 1970′s has seen exceptional (and well-publicized) increases in oil, energy and food prices, as well as huge income gains by many groups, these were not the basic causes of the severe inflation, but rather contributing factors to it. In the view of most economists, the basic causes of the rapid inflation of the 1970′s lay in exceptional increases in aggregate demand, which simply outran the economy’s capacity to produce, thus generating the worst inflation in many years. Underlying these however, because the economy and the appropriate money supply generally grow from year to year, it is not often appropriate for the Bank of Canada to actually reduce the money supply, except for quite short periods. The question, rather, is generally how rapidly the money supply should be allowed to increase. When the Bank of Canada is seeking to slow down the rate of growth of the money supply by restraining the lending activities of the banks, these policies are also generally described as “tight money policies.”

Thus, the primary tool of monetary policy is the open-market operations of the Bank of Canada, in which purchases and sales of bonds by the Bank of Canada increase and decrease the banks’ cash reserves, and thus the money supply. The Bank of Canada, however, does have other methods of influencing the volume of lending by the banks and thus the money supply, some of which are discussed in the following sections.

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