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Basics The


									    The Bank of Canada (The
The Bank of Canada is Canada’s central

A central bank is a public authority that
  supervises financial institutions and
  markets and conducts monetary policy
       Bank of Canada: History

Created by the Bank of Canada Act of 1935
Was privately own until 1938. That is:
   The   shares were sold to the public;
   The  dividends were limited up to 4.5%, the rest –
    to the govt.

A Governor of the Bank is appointed by the
  govt of Canada for 7 year term
   Currently:   David Dodge
                Monetary Policy

 Monetary policy is the attempt to control
 inflation and moderate the business cycle by
     the quantity of money in circulation
   the   interest rates
   the   exchange rate.
 Responsibility for Monetary
 Independent central bank

Canada until 1967, USA, Germany, Switzerland

 Subordinate central bank

Canada since 1967 (Amendment to the Bank of
 Canada Act after the clash between Governor
 James Coyne and Prime Minister John
 Diefenbaker in 1961)
    Independent Central Bank
An independent central bank is one that
 determines the nation’s monetary policy
 without interference from govt.

Argument: Independent Bank is able to pursue
  the long-term goal of price stability and can
  prevent monetary policy from being used for
  short-term, political advantage.
       Subordinate Central Bank
The govt (the minister of Finance has final
 responsibility for monetary policy.
Argument: monetary policy is so important
  that it should be subject to democratic
The governor is powerful – as long as
 he/she is willing to implement gov’t
           Dual Responsibility
The Bank formulates and carries out
 monetary policy
The Minister of Finance can issue a
 directive to the Bank if the govt
 disapproves the bank’s policy.
The governor can not refuse to resign.
             The Functions of
           the Bank of Canada
 To conduct monetary policy

 To act as lender of last resort

 To issue the country’s bank notes

 To act as a financial adviser and a fiscal
  agent to the federal govt:
   beresponsible for the govt of Canada debt
 To regulate payment and settlement system
         The Monetary Base
The liabilities of the Bank of Canada are the
 largest component of the monetary base.

The monetary base (MB) is the sum of the
 Bank of Canada notes outside the Bank,
 chartered banks’ deposits at the Bank of
 Canada, and coins held by HHs, firms,
 and banks.
  3 components of monetary
 monetary policy objectives

 monetary policy indicators

 monetary policy tools
   Monetary Policy Objectives
“regulate credit and currency in the best interests
   of the economic life of the nation … and to
   mitigate by its influence fluctuations in the
   general level of production, trade, prices and
   employment, so far as may be possible within
   the scope of monetary action…”
                        Bank of Canada Act, 1935

Current objective: keep the inflation rate between
 1% and 3% a year and smooth fluctuations as
 much as possible.
   Monetary Policy Indicators
Monetary policy indicators are the current
 features of the economy that the Bank
 closely watches.
The best ones are those that
 are accurately and frequently observable

 are good predictors of real GDP growth,
 employment, and inflation
 can control quickly by the Bank
       The Overnight Loans Rate

The overnight loans rate is the interest rate
 on large-scale loans that chartered banks
 make to each other and to dealers in
 financial markets.

It’s the main policy indicator.
Overnight rate
       Monetary Policy Tools
Four policy tools impact on bank reserves and
 the quantity of money (M):

 Required reserve ratio (RRR)

 Bank rate and bankers’ deposit rate

 Open market operations

 Government deposit shifting
            RRR: before 1992
The banks were required to hold a fixed proportion of
  deposits in reserves

  - in the form of currency and deposits at the Bank
  of Canada

  - to ensure they are able to meet the demands of
  their customers.

  - until 1967 – 8%, then less and less…

By changing RRR, the Bank of Canada changes the
  amount of lending the banks can do.
          RRR After 1992
Required reserves act like a tax on the
The opportunity cost of reserves = forgone
RRR was abolished in 1992.
Now, banks in Canada have not been
 required to hold reserves: RRR = 0.
This action has made the banks in Canada
 more profitable.
             The Bank Rate
The Bank of Canada stands ready to lend
 reserves to banks to ensure that they can
 always meet their depositors’ demands for
  the banks can manage with small reserves

The bank rate is the interest rate that the
 Bank charges the chartered banks on the
 reserves it lends them.
      Bankers’ Deposit Rate
The bankers’ deposit rate is the interest rate
 that the Bank pays the chartered banks on
 the deposits at the Bank.

It is 0.5% less than the bank rate.

The Bank can always make the overnight
 loans rate hit its target range by its setting
 of the bank rate and the bankers’ deposit
 The Bank of Canada’s Official
The Bank of Canada’s official rate (or key policy
  rate) is the Target for the Overnight Rate,
  which is the midpoint of the Bank’s Operating
  Band for overnight financing.

The official rate was formerly the Bank Rate,
  which is the upper limit of the operating band.

Announcements regarding the official rate are
 made on eight fixed, or pre-specified, dates
 each year.
  Open Market (OM) Operations

An open market operation is the purchase
 or sale of govt of Canada securities —
 Treasury bills and govt bonds — by the
 Bank of Canada from or to a chartered
 bank or the public.

OM operations are the main method of
 controlling bank reserves and the money
        Govt Deposit Shifting
Govt deposit shifting is the transfer of govt
 funds by the Bank from the govt’s account at
 the Bank to or from its accounts at the
 chartered banks.

It’s fine-tuning the bank reserves.

The volume is about 250 times less than the
 volume for the OM operations.
 Controlling the Money Supply

When the Bank of Canada buys securities
 in an OM operation =>

=> the monetary base 

=> banks’ lending 

=> the quantity of money 
   Monetary Base and Bank
MB  => bank reserves  and currency
 held by HHs and firms  .

Only the increase in bank reserves can
 be used by banks to make loans

=> create additional money.
           Money Multiplier
The money multiplier is the amount by which
 the quantity of money changes from a
 change in the monetary base.

Compare it to the deposit multiplier: the
 deposit multiplier shows how a change in
 bank reserves changes bank deposits.

      Money multiplier      .
        A Currency Drain

A currency drain makes the money
  multiplier smaller.

A currency drain occurs when people hold
  currency rather than deposit the currency
  in banks.

It reduces the amount of banks’ reserves
   and decreasing the amount that banks
   can loan.
        Interest Rate Fluctuations
The first effect of monetary policy is a change
 in all interest rates.
It occurs quickly and relatively predictably.
- The Bank targets directly the overnight loans
  rate (OLR).
- The short-term rates (3-month Treasury bill,
  short-term corporate debt) follow OLR.
- 10-year govt bond rates move in the same
  direction, but fluctuates less.
        Money Supply Target Vs.
          Interest Rate Target
The Bank can not keep fixed both the quantity of
   money and the interest rate because the demand
   for money fluctuates. Thus, the choice:
A. Money supply target: to keep the quantity of money
   stable, let the interest rate fluctuate.
B. Interest rate target: to keep the interest rate stable,
    let the quantity of money fluctuate.
The Bank chooses to keep interest rate stable (B).
To raise the interest rate the Bank decreases the
   average quantity of money by decreasing bank

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