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 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
The Bank formulates and carries out
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,
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
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
It’s the main policy indicator.
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
- to ensure they are able to meet the demands of
- 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
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
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
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.
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
A currency drain occurs when people hold
currency rather than deposit the currency
It reduces the amount of banks’ reserves
and decreasing the amount that banks
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
- 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