The Bank of Canada (The Bank)

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The Bank of Canada (The Bank)

• The Bank of Canada is Canadas central bank.
• A central bank is a public authority that
  supervises financial institutions and markets and
  conducts monetary policy
• http//www.bankofcanada.ca/

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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

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Monetary Policy

• Monetary policy is the attempt to control
  inflation and moderate the business cycle by
  changing
• the quantity of money in circulation
• the interest rates
• the exchange rate.

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Responsibility for Monetary Policy

• 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)

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Independent Central Bank

• An independent central bank is one that
  determines the nations 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.

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Subordinate Central Bank

• The govt (the minister of Finance has final
  responsibility for monetary policy.
• http//www.fin.gc.ca/
• Argument monetary policy is so important that it
  should be subject to democratic control.
• The governor is powerful as long as he/she is
  willing to implement govt policies.

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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 banks
  policy.
• The governor can not refuse to resign.

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The Functions of the Bank of Canada

• To conduct monetary policy
• To act as lender of last resort
• To issue the countrys bank notes
• To act as a financial adviser and a fiscal agent
  to the federal govt
• be responsible for the govt of Canada debt
  management
• To regulate payment and settlement system

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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.

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3 components of monetary policy

• monetary policy objectives
• monetary policy indicators
• monetary policy tools

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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.

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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

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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.
• Its the main policy indicator.

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Overnight rate
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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

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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.

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RRR After 1992

• Required reserves act like a tax on the banks.
• The opportunity cost of reserves forgone
  interest.
• 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.

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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 currency ?
• 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.

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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 rate.

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The Bank of Canadas Official Rate

• The Bank of Canadas official rate (or key policy
  rate) is the Target for the Overnight Rate, which
  is the midpoint of the Banks 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.

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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 supply.

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Govt Deposit Shifting
Govt deposit shifting is the transfer of govt
funds by the Bank from the govts account at the
Bank to or from its accounts at the chartered
banks. Its fine-tuning the bank reserves. The
volume is about 250 times less than the volume
for the OM operations.
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Controlling the Money Supply

• When the Bank of Canada buys securities in an OM
  operation gt
• gt the monetary base ?
• gt banks lending ?
• gt the quantity of money ?

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Monetary Base and Bank Reserves

• MB ? gt bank reserves ? and currency held by
  HHs and firms ? .
• Only the increase in bank reserves can be used by
  banks to make loans
• gt create additional money.

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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.

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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.

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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.

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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
  reserves.